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A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer (the creditor of the reference loan) in the event of a loan default (by the debtor) or other credit event. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. It was invented by Blythe Masters from JP Morgan in 1994.

In the event of default the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan.[1] However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). If there are more CDS contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction; the payment received is usually substantially less than the face value of the loan.[2]

Credit default swaps have existed since the early 1990s, and increased in use after 2003. By the end of 2007, the outstanding CDS amount was $62.2 trillion,[3] falling to $26.3 trillion by mid-year 2010[4] but reportedly $25.5[5] trillion in early 2012. CDSs are not traded on an exchange and there is no required reporting of transactions to a government agency.[6] During the 2007-2010 financial crisis the lack of transparency in this large market became a concern to regulators as it could pose a systemic risk.[7][8][9][10] In March 2010, the [DTCC] Trade Information Warehouse (see Sources of Market Data) announced it would give regulators greater access to its credit default swaps database.[11]

CDS data can be used by financial professionals, regulators, and the media to monitor how the market views credit risk of any entity on which a CDS is available, which can be compared to that provided by the Credit Rating Agencies. U.S. Courts may soon be following suit.[1]

Most CDSs are documented using...