New York / London: The most comprehensive report on unregulated credit default swaps (CDSs)

Down and out: A file photo of an employee at AIG headquarters in New York. AIG first disclosed to investors in August 2007 that it held at least $440 billion of credit swap trades linked to CDOs. Brendan McDermid / Reuters

A study by the Depository Trust and Clearing Corp. (DTCC) fails to include privately negotiated credit swaps that insurers such as AIG, MBIA Inc. and Ambac Financial Group Inc. sold to guarantee securities known as collateralized debt obligations (CDO), according to analysts, including Andrea Cicione at BNP Paribas SA in London.

New York-based DTCC’s report, released on its website on 4 November, showed a total $33.6 trillion of transactions on governments, companies and asset-backed securities worldwide, based on gross numbers. While designed to ease concerns about the amount of risk banks and investors amassed on borrowers from companies to homeowners, the study may have missed as much as 40% of the trades outstanding in the market, Ciccone said.

The data is “likely to underestimate the amount of net CDS exposure", he said in an interview.

Trading of credit derivatives soared 100-fold the past decade as banks, hedge funds, insurance companies and other investors used the contracts to protect against losses or speculate on debt they didn’t own.

Banks worldwide have taken $693 billion in write-downs and losses on loans, CDOs and other investments since the start of 2007, according to Bloomberg data.

AIG first disclosed to investors in August 2007 that it held at least $440 billion of credit swap trades linked to CDOs. The New York-based company was brought to the edge of bankruptcy in September after the value of the transactions plunged. The insurer was forced to come up with at least $10 billion in collateral to back the contracts after its debt rankings were cut. It accepted an $85 billion government loan in exchange for ceding control to the US.

MBIA and Ambac, previously the world’s two biggest bond insurers, lost their top AAA ratings earlier this year because of potential losses on credit swaps sold to guarantee CDOs backed by home loans. Moody’s Investors Service cut New York-based Ambac’s bond insurance rating four levels on Wednesday to Baa1, three steps above junk, because of potential losses on the derivatives.

A market survey this year by the New York-based International Swaps and Derivatives Association, which includes credit swaps on CDOs and other contracts that may not be captured by DTCC’s Trade Information Warehouse, estimates that at least $47 trillion in gross contracts are outstanding.

The Federal Reserve Bank of New York, which urged dealers to curb risks and improve transparency in the credit swaps market over the past three years, said regulators will continue to push for more disclosure. Among the information the Fed wants to see are prices at which the derivatives trade, according to a New York Fed spokesman.

“There appear to be gaps," said Henry Hu, a law professor at the University of Texas in Austin, who has pressed for the creation of a data warehouse encompassing all privately negotiated derivative trades to offer a better understanding of their risks. “Hopefully, regulators are getting more information."

Because the DTCC registry captures only commonly traded contracts that can be confirmed over electronic systems, not every swap trade is in the company’s report, spokeswoman Judy Inosanto said. Among those not included are CDSs on CDOs, she said.

MBIA, the Armonk, New York-based insurer crippled by ratings downgrades earlier this year following losses from such contracts, has said it sold $126.3 billion in guarantees on slices of CDOs backed by corporate bonds, mortgages and other debt. Ambac sold $60.7 billion in guarantees on these so-called tranches, mostly through credit swaps, the company said.

Insurers, including AIG, MBIA and Ambac, typically sold protection on the highest ranking slices of such deals, meaning they’d be required to make good on payments only after a substantial part of the underlying debt defaults.

After the failures of Lehman Brothers Holdings Inc., Washington Mutual Inc. and three Icelandic banks that were widely held in CDOs linked to corporate debt, the defaults caused no losses on tranches MBIA guaranteed, Mitchell Sonkin, the company’s head of insured portfolio management, said in a conference call.

The failure of Lehman, WaMu and the Icelandic lenders caused losses of at least 90% to investors holding riskier slices of such CDOs that have less protection against defaults.

“The worry is that these bespoke tranches are being eaten away, and who knows if and when these losses will get realized," Tim Backshall, chief strategist at Credit Derivatives Research Llc. in Walnut Creek, California, wrote in a note to clients on Wednesday.