Credit Derivatives: A crystal ball for treasury managers?

by Farooq Jaffrey, CEO, Traccr Limited 

Credit default swaps (CDS) are rapidly becoming a vital risk measurement tool in treasury management. Credit spreads, and their rise or fall, provide a real-time barometer to measure and assess counterparty risk. Screen-based credit pricing is increasingly important to businesses which have historically relied on traditional methods of measuring credit risk to suppliers, customers, debtors and bank counterparties.

Business is based on credit. In order to manufacture, trade or grow, a company needs access to working capital and companies are generally both borrowers and lenders. Finance directors are adept at understanding how financing costs and counterparty risk can impact the financial integrity of their company. After several years of a relatively benign economic environment and easy access to capital the importance of measuring counterparty risk accurately is now recognised as a top priority.

The well documented Great Credit Crackup of 2007 was indiscriminate and many experienced financiers, traders and companies were caught unprepared. Bankruptcies, credit lines pulled, bailouts and malfunctioning capital markets had a previously unimaginable ripple effect. A meteorologist can use digital satellite imaging to assess conditions far enough in advance to evacuate and save people from a natural disaster but no one predicted the catalyst that finally triggered the credit implosion and sent worldwide markets into freefall.

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