Increasing transparency: Putting the “see” in CDS

This week the Depository Trust & Clearing Corporation (DTCC), one of three clearing houses for credit-default swap (CDS) trades, began publishing weekly data on outstanding credit-default swaps on 1,000 debt issuers, including GE Capital Corporation. We strongly support full disclosure and increased transparency for the CDS market. We believe a more open market where positions are clear and traded on an open exchange would help bring additional stability to the market. GE is one of the most widely held CDS because GE Capital is one of the largest issuers of corporate debt.

GE’s CDS spreads widened during the financial crisis, but have come in recently. The pricing of credit default swaps reflects a thinly-traded instrument in an unregulated market that has proven to be prone to significant distortion. Greater transparency and disclosure in the form of regulatory oversight will help address these issues.

What is a credit default swap?

A CDS is essentially an insurance policy designed to reimburse the holder of a debt instrument if, for example, the company issuing the debt defaults on its obligation. Investors who own debt securities can purchase CDS as a way to hedge their exposure. Other investors who don’t own the underlying debt can buy or sell CDS as a way of “taking a position” or making a bet on the prospects of a company, a sector or the economy overall, or as part of a complex trading strategy.

In normal market conditions, CDS prices can be viewed as one measure of the market’s opinion of a company’s credit quality, and they generally track prices on the underlying debt. In the current credit market turmoil, however, there has been enormous volatility in CDS prices, even within the course of a single day, as investors have become extremely risk adverse. While the CDS market is very large, trading in individual CDS is quite often thin and unpredictable. The market is unregulated and is now under investigation for manipulation.

What impact do credit default swaps have on GE’s debt?

CDS prices don’t have a direct impact on GE’s funding costs, which are driven by the prices at which we can issue debt. In the current credit market turmoil, there is a wide divergence between where our debt and CDS instruments trade. Given the limitations of the CDS market, we believe the market prices of our debt represent a more accurate gauge of market sentiment regarding GE’s financial strength and credit quality.