Almost a year into the credit crunch, it appears that there are still widespread market fears of another financial firm going under. And it seems that the next six months are crucial in terms of whether those fears will become reality. A study of more than 140 largely US-based hedge funds, banks and investment managers conducted by consultant Greenwich Associates highlights substantial concerns around risk in the credit default swaps (CDS) market. According to the firm’s research, 90% of hedge funds say they believe counterparty risk in the CDS market poses a significant threat to global markets. Most of the concerns were expressed by US-based institutions (85%), compared to 55% of firms in Europe that cited counterparty risk as a concern.
Perhaps the most alarming finding is that almost 60% of firms believe that another financial services firm will go under in the next six months. Another 15% say it could happen in six to 12 months. Commenting on the findings, Greenwich Associates consultant Frank Feenstra says that it seems most institutions believe global financial services firms are currently in the most dangerous period. “Perhaps if the markets can make it through the next six months,” he says, “the level of pessimism may begin to subside.”
Concerns about counterparty risk in the CDS market has prompted many firms to scale back participation in the market, with almost two-thirds of fixed-income participants saying they had limited their use. Other firms have tried to reduce risk by limiting the concentration of their exposure to single counterparties, hedging and the use of cross-collateral arrangements. More than 70% of firms surveyed supported the idea of a centralized clearing entity for reducing counterparty risk in the CDS market. And given the financial dark clouds still hanging over the banking sector, it was not surprising that most firms believe a centralized clearing platform should be operated by an exchange rather than the banks.