As the rules for the new, more automated and more regulated OTC derivatives markets takes shape, we're seeing some interesting sparring over CDSs and the extent to which they are hedged by the big dealers.

One proposal has called for the industry to report trades within 15 minutes of consummation. The industry's response has been that reporting in 15 minutes would leave them precious little time to hedge the trade. But Bloomberg now reports that the Fed has studied the issue and concluded that the biggest 14 banks didn't offset large corporate or sovereign CDS trades with customers on the same day 45 percent of the time.

"Our analysis seems to suggest that requiring same day reporting of CDS trading activity may not significantly disrupt same day hedging activity, since little such activity occurs," the Fed report was quoted.

"It will be important for policy makers to gauge what impact greater post-trade transparency would have on dealers' existing approach of holding onto risk and trading out of positions gradually" because "this behavior is important in facilitating trading in the CDS market."

The findings suggest how adept the dealers are at generating proprietary gains from CDS market making activities, as we would expect. They are certainly willing to hold the risk in hopes of capital gains. That said, they do hedge more than half the times, so the rules should take this into account. It may be that a 15 minute window is not enough. But at some point, all trades ought to be reported in the interests of transparency.

For more:
- here's the Bloomberg article

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