What's more, CDS futures won't take off just because the market wants to take directional bets on credit; they'll take off because they provide an economic incentive to those wanting to take directional bets on credit. If no bottom-line benefit exists for potential users of the product, whether via lower margins or tighter spreads, there is no reason why anyone would trade a future over a swap -- or make any product selection changes, for that matter.
But wait. We just said that margin rates for futures will be lower than for comparable swaps, right? It could even be argued that margin rates for cleared CDSs and the comparable cleared CDS future should be the same. If they're economically equivalent, then why wouldn't margin requirements be equivalent? This question brings us to the logical conclusion that in the next few years, margin requirements for swaps and swap futures will come more in line with one another, taking away the margin benefit futures might provide.
What about the fact that the benefits of cross-product netting are not available between swaps and futures positions? For interest rate swap futures, such as those offered by the Eris Exchange, natural offsets exist with Eurodollar and Treasury futures, as these products are highly correlated based on current interest rates. For CDS futures, however, there is no obvious offsetting contract. I'm sure quants could find arbitrage trades between CDS index futures and S&P 500 futures as they both track the health of a company, but the correlation is not close enough to create any noticeable offsets.
A Forgone Conclusion
It is inevitable that one or more exchanges will bring CDS futures to market as new over-the-counter derivatives regulations take effect this year and next. To reiterate, the potential upside if successful is just too big to ignore.
The irony here, however, is that after legislators and regulators spent years trying to convince the world that CDSs are evil and have caused everything from the credit crisis to the rising price for a cup of coffee at Starbucks, the rules they are putting in place to control the market in fact drive more rather than fewer people to take bets on creditworthiness. To my mind, that's either an unintended consequence or proof that CDSs are a viable product that investors have come to need.
Kevin McPartland is Principal and Director of Fixed Income Research for Tabb Group. He blogs at kevinonthestreet.com