*Background Information
Over the past few years, credit default swaps (CDS) have become the most dominant product of the credit derivatives market. According to the Bank for International Settlements, the estimated notional amount of outstanding CDS was $42.6 trillion in June 2007, up from $28.9 trillion in December 2006 and $13.9 trillion in December 2005.
The CDS market has recently become the focus of attention for both market participants as well as regulators because of the turmoil in credit markets during 2007 and 2008. Recently, some sellers of credit derivatives have been faced with severe adverse conditions. For example, they are facing actual and potential defaults on a large number of referenced obligations that their CDS are guaranteeing. As a result, the sellers of credit derivatives may have large liabilities associated with those actual and potential defaults. In addition, sellers are facing the potential of a credit downgrade or have already been downgraded by one or more credit-rating agencies. For the buyers of these credit derivatives, the seller’s credit-rating downgrade could have significant adverse consequences because the downgrade would affect the fair value of the purchased credit derivative.
Concerns have been expressed as to whether the disclosure requirements in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, adequately address the potential adverse effects of changes in credit risk on the financial position and performance of the sellers and buyers of credit derivatives. In view of these developments, the Board added a short-term project to its agenda to improve disclosures about credit derivatives.
