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What it takes to deal with success: How is the market dealing with the CDS backlog?

Dealers say the backlog of unconfirmed credit default swap trades has been reduced by 54% since September 2005. The New York Fed is asking for a further reduction by the end of June this year. How near is the market to having an infrastructure able to cope with massive growth and a broadening of the uses of CDS? Helen Avery reports.

PETER NOLAN IS not convinced that buyers and sellers of credit default swaps are fully aware of their exposure. He works for Lysis Financial, dealing with project management in operations and technology for banks that deal in structured credit products. “Banks in the industry are continuously uncovering new exposures to General Motors through credit default swaps,” he warns. “There are risks that people aren’t cognizant of because of old documentation. Every bank is trying to improve its systems but at large organizations there are still legacy trades that are difficult to track. Documentation has altered with the growth in the market and legacy exposure can be hard to work out. How much risk is hiding in those dark corners?”

The question cannot yet be answered. No one predicted that the CDS market would grow as fast it has since its inception in the 1990s and that the infrastructure would not be able to cope with the ballooning volumes. Some market observers even suggest that some trades executed years ago are still unconfirmed.

According to the International Swaps and Derivatives Association, the notional amount of CDS outstanding at the end of 2003 was $3.58 trillion. In June 2005, the figure exceeded $12 trillion.

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