## F.5 Treatment of Credit Default Swaps: Classification by Type and Risk Category (Approved/Final Version)

## Source details

**Canonical URL:** [F.5 Treatment of Credit Default Swaps: Classification by Type and Risk Category (Approved/Final Version)](https://www.imf.org/-/media/files/data/statistics/bpm6/approved-guidance-notes/f5-treatment-of-credit-default-swaps.pdf)

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### Background and issue
- BPM6 and 2008 SNA classify derivatives into two types: option-type and forward-type (BPM6 paragraphs 5.85, 5.86, 5.88).
- BPM6 paragraph 5.93 identifies credit derivatives as taking the form of both forward-type (total return swaps) and option-type contracts (credit default swaps).
- The classification question arises because CDS exhibit characteristics of both option-type and forward-type contracts, notably the potential to switch from asset to liability depending on credit quality of the reference entity.
- Market context: BIS measure of gross market value of OTC CDS suggests amounts outstanding close to $0.2 trillion.

### Characteristics analysis (comparison)
- Key descriptive points about CDS:
  - CDS enable investors to buy protection against a credit event on a specified reference entity; the protection buyer pays periodic fees (CDS spread) and may pay or receive an upfront premium if the standard rate differs from required market compensation.
  - After a defined credit event, the protection buyer receives a payment intended to compensate for loss on the investment.
  - CDS buyers need not hold the underlying claim (naked CDS).
  - Protection buyer is considered short; protection seller is long. Buyer benefits when credit quality deteriorates and CDS spread increases; seller benefits when credit quality improves and spread declines.
- Table 1 (characteristics summary) — exact categorical matches reported:
  - Up-front fee/premium: Forward-type = No; Option-type = Yes; CDS = Yes
  - Regular fees/premiums: Forward-type = No; Option-type = No; CDS = Yes
  - Potential to switch from asset to liability and vice versa: Forward-type = Yes; Option-type = No; CDS = Yes
  - Binding obligation at maturity: Forward-type = Yes; Option-type = No; CDS = No
  - Contingent claim: Forward-type = No; Option-type = Yes; CDS = Yes
  - Margin payments: Forward-type = Yes; Option-type = Yes; CDS = Yes
  - Exchange traded or OTC: Forward-type = Both; Option-type = Both; CDS = OTC
- Interpretation: CDS share a mix of forward-like and option-like characteristics; no single shared characteristic decisively aligns CDS with only one type.

### Outcomes considered
- Three possible recommendations considered:
  - i. continue to classify CDS as option-type;
  - ii. reclassify CDS as forward-type;
  - iii. recommend supplementary breakdowns of financial derivatives by risk categories where credit derivatives would be separately identified.
- Recommended option:
  - Continue to classify CDS as option-type.
  - Rationale: CDS main features are closer to put options—both are contingent claims and unilateral contracts; put options compensate holder for poor performance of the underlying, analogous to CDS compensation after default.
- Rejected option:
  - Reclassifying CDS as forward-type was rejected.
  - Rationale: Although CDS can switch from asset to liability, weighing characteristics (Table 1) did not provide a strong enough basis to move CDS from option-type to forward-type.
  - The recommendation may be reviewed in light of outcomes from topic F.4 (Financial derivatives by type) when available.

### Additional recommendations
- Include a brief explanation or text box in the next international standards highlighting main CDS characteristics (akin to paragraphs 7–10) and provide guidance on valuation of CDS contracts in both the financial account and international investment position.
- Introduce supplementary breakdowns of financial derivatives by risk categories to separately identify credit derivatives to enhance analytical usefulness. The F.5 co-authoring team proposes these supplementary breakdowns and recommends F.4 consider them.

### Results of consultations and governance follow-up
- Majority of FITT, BPTT, and Committee on Balance of Payments Statistics members supported maintaining CDS classification as option-type, while a minority saw greater similarity with forward-type contracts.
- Some Committee members requested the manual clarify that despite being option-like, CDS market value can turn from positive to negative and vice versa.
- FITT and BPTT members unanimously supported the supplementary breakdowns by risk categories.
- The Committee requested the proposed supplementary table be forwarded to the F.4 co-authoring team for comprehensive assessment; depending on F.4 outcomes, the Committee could revisit its decisions.

### Proposed supplementary risk-category breakdown (for consideration by F.4)
- By type (Existing):
  - Options
  - Forward-type contracts
- By market risk categories (New):
  - Foreign exchange
  - Single-currency interest rate
  - Equity
  - Commodity
  - Credit
  - Other

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_Source: https://www.imf.org/-/media/files/data/statistics/bpm6/approved-guidance-notes/f5-treatment-of-credit-default-swaps.pdf_