Notwithstanding the post-global financial crisis regulatory reforms, derivatives markets have continued to experience episodes of stress, often requiring public intervention. While the reforms focused on counterparty risk, these disruptions highlight the importance of liquidity, concentration, and features of market microstructure as channels of systemic risk.

Credit default swaps (CDSs) exemplify these. Although CDS spreads are widely regarded as key indicators of credit risk, analysis based on granular transaction-level data uncovers a range of market imperfections. Most notably, CDS spread formation is driven by limited trading activity and a high degree of concentration among a small subset of counterparties. These features can affect market function under financial stress by increasing systemic risks through price-related impacts on funding costs.

This column summarises key findings from a recent European Systemic Risk Board (ESRB) analysis of the CDS markets in the EU (ESRB 2025). The findings support policy measures to boost transparency, strengthen oversight, improve market functioning, and reduce the risks of over-reliance on CDS spreads as credit risk benchmarks.

Background

Credit default swaps are derivatives that transfer credit risk between counterparties, allowing long or short positions to be taken on the creditworthiness of an entity, and may be employed for hedging or speculative purposes, including the synthetic replication of exposures to the underlying credit instruments. The 2008 global financial crisis and the 2010–2014 euro area sovereign crisis exposed major structural weaknesses in the financial system, with CDSs playing a central role in spreading systemic risk. The opacity of CDS markets hindered policymakers from assessing risks, increasing uncertainty. Additionally, practices like short selling using CDSs worsened price pressures and market instability.

As derivative instruments, CDSs are typically viewed as directly reflecting conditions in underlying markets. But they can also exert feedback effects, notably by influencing the funding costs of reference entities. CDS spreads have become critical benchmarks for credit risk assessment (and for deriving implied default probabilities), thereby influencing asset prices, market liquidity, and investor sentiment. They are extensively referenced by market participants and policymakers, as well as in public discourse (e.g. in media coverage and policy debates), particularly in the context of sovereign debt. During market stress, widening spreads often lead to lower bond prices and higher borrowing costs, and can further drive financial instability through feedback loops.

Market structure and microstructure

Despite their significance, the mechanisms underpinning CDS spread formation and the role of market microstructure in liquidity dynamics remain insufficiently understood. This gap is primarily attributable to the historical opacity in CDS markets and, until recently, the scarcity of granular transaction-level data. The introduction of detailed transaction-level reporting under the European Market Infrastructure Regulation (EMIR) has enabled more advanced analyses.

Academic and policy discussions, as well as public and industry commentary, often cite outstanding gross notional amounts to quantify derivatives market ‘size’. However, this measure reveals little about actual risk transfer, market structure, or price discovery. Notably, the outstanding gross notional in the global single-name CDS market has dropped significantly since 2007, from about US$60 trillion to under $10 trillion by 2023. This decline, rather than directly reflecting a change in trading activity, is mainly due to the use of trade compression, a technique that cancels offsetting claims and reduces gross notional amounts without altering net positions (D’Errico and Roukny 2020).
Widely applied in derivatives markets, including CDSs, but rarely used in other debt markets (Aldasoro and Ehlers 2018), compression can reduce outstanding gross notional amounts by up to 80% (D’Errico and Roukny 2020).

With respect to CDS spread formation, transaction-level data reveal significant market imperfections in single-name CDS markets: limited liquidity, low trading volumes, and high concentration among participants. In fact, price-forming transactions are infrequent and concentrated along three key dimensions: trading counterparties, reference entities, and time. A small group of counterparties account for the majority of price-setting activity, typically involving a narrow set of reference obligations and clustering around major market events or periods of stress.

This implies that single-name CDS markets do not exhibit the characteristics of highly liquid and competitive markets. During periods of stress, the limited number of active participants may be unable to supply sufficient liquidity to absorb surges in demand, thereby amplifying market instability.
Market opacity further creates information asymmetries that undermine competition and price discovery, and raise barriers to entry.

The first key market imperfection is the persistently low trading volumes compared to outstanding issuer debt. Even the most actively traded EU global systemically important bank (G-SIB) and sovereign CDSs see limited activity, with Italy’s CDSs averaging just $571 million in daily notional across 13 trades, and most other EU sovereign CDSs recording only five to seven trades per day (Figure 1).

Consequently, single-name credit default swap markets may be characterised as “shallow and illiquid”, according to Andrea Enria, former Chair of the Supervisory Board of the ECB (Enria 2023) – a view shared by the International Swaps and Derivatives Association (ISDA 2023).

Figure 1 Average daily trading activity in CDSs on EU sovereign entities on the global market

Notes: Figures are based on the following reference entities: all EU sovereign entities, other than Estonia, Cyprus, Luxembourg and Malta.
Sources: Depository Trust & Clearing Corporation.

The second major imperfection in the market structure is the concentration of trading among a small number of counterparties. Figure 2 shows that, before 2021, the leading participant accounted for 26% of daily trading volume, even with around twenty active participants. This concentration intensified after the UK left the EU, when UK entities stopped reporting to EU authorities. Ideally, each counterparty would contribute 5–9% of trades, but the observed deviation highlights the dominance of certain institutions and their influence on price formation in single-name CDS markets.

Figure 2 Average daily distinct versus effective traders per EU-reported sovereign CDS

Notes: Price-forming trades only. The sample period consists of two-month snapshots in March-April of each year.
Source: European Market Infrastructure Regulation (EMIR) reporting data.

Regulatory framework for transparency in CDS markets

In response to the global financial crisis, the EU has adopted a regulatory framework to address systemic risk in derivatives, including CDS markets, which centres on two key legal acts:
(i) EMIR, which mandates reporting of all derivatives contracts and central clearing for certain standardised OTC contracts (single-name CDSs are not under the clearing obligation, due to their illiquidity and low trading frequency, but are subject to risk-mitigation techniques); and (ii) the Markets in Financial Instruments Regulation (MiFIR), which aims to improve financial markets’ transparency and oversight, mandating the trading of derivatives on organised trading venues (also not applicable to single-name CDSs).

A recent review extended MiFIR transparency requirements
to cover some centrally cleared single-name CDSs and CDS indices referencing EU G-SIBs, but its scope remains limited since most single-name CDSs are not centrally cleared: fewer than 30% of CDSs referencing EU G-SIBs are cleared, a share that further declined below 20% in May 2023. Deferrals on disclosure of CDS transactions, aimed at protecting the liquidity of these markets, further limit post-trade transparency.

The limitations are further compounded by the global nature of CDS trading. A large share of CDS contracts referencing EU sovereigns and G-SIBs are traded outside the EU, primarily in the UK and the US, and therefore fall outside EU transparency and reporting requirements. This constrains authorities’ ability to monitor cross-border exposures and detect emerging vulnerabilities.

Experiences in other jurisdictions also provide valuable insights. In the UK, the regulatory framework has recently evolved towards a more targeted post-trade transparency regime for derivatives.
This regime provides for mandatory post-trade transparency for the most liquid CDS indexes but greater flexibility regarding single-name CDSs, as trading venues are expected to calibrate the adequate level of transparency. In the US, on the other hand, all CDS transactions, whether cleared or uncleared, must be reported to swap data repositories (SDRs) or security-based swap data repositories (SBSDRs), which make such information available to the public as soon as technologically practicable. EU policymakers should note that, since 2022, real-time post-trade transparency in the US has not adversely affected market liquidity.

Policy considerations

The analysis of the CDS market structure combined with the regulatory framework led to findings regarding the role of CDSs in credit markets, market structure, market transparency, and supervisory reporting and data quality. The ESRB report puts forward a set of policy proposals aimed at improving the market functioning and liquidity, enhancing transparency, and strengthening the quality of information available to authorities.

First, the report proposes enhancing post-trade market transparency for single-name CDSs. This may be achieved by adjusting the EU’s regulatory regime to apply at least to single-name CDSs on EU G-SIBs and EU sovereigns, regardless of whether they are centrally cleared and how they are traded. 

Second, the report proposes strengthening supervisory access to information through improved quality and standardisation of the data reported to authorities, as well as enhanced global cooperation (particularly relevant due to the global nature of CDS trading). The report also suggests developing a real-time monitoring tool for CDS markets to enable potential timely macroprudential interventions (i.e. during periods of systemic market stress).

The third policy proposal focuses on improving the efficiency and functioning of the single-name CDS market. This requires identifying and addressing structural factors limiting demand, supply, and competition in this market.

Fourth, it is necessary to improve credit risk assessment frameworks by reducing excessive reliance on CDS spreads and raising awareness of the structural limitations associated with price-formation mechanisms. Given these limitations, all stakeholders should exercise caution when relying on CDS spreads as indicators of credit risk, particularly during periods of stress.

The proposed policy measures should form a medium-term roadmap to improve the functioning of single-name CDS markets and address the related systemic risks.

References

Aldasoro, I and t Ehlers (2018), “The credit default swap market: what a difference a decade makes”, BIS Quarterly Review, June.

Börner, L and J W Hatfield (2017), “The design of debt-clearing markets: Clearinghouse mechanisms in preindustrial Europe”, Journal of Political Economy 125(6): 1991-2037.

D’Errico, M and T Roukny (2020), “Compressing over-the counter markets”, Operations Research 69(6): 1660-1679.

Enria, A (2023), “A new stage for European banking supervision”, keynote speech at the 22nd Handelsblatt Annual Conference on Banking Supervision.

ESRB – European Systemic Risk Board (2025), Credit default swaps – analysis and policies.

IOSCO – International Organization of the Securities Commissions (2015), Report on Post-Trade Transparency in the Credit Default Swaps Market.

IOSCO (2025), Single-Name Credit Default Swaps Market.

ISDA – International Swaps and Derivatives Association (2023), Understanding risk management and liquidity in Single Name CDS and what this means for the MIFIR transparency regime.