Feature: What Is a CDS (Credit Default Swap)? How It Works, How It Is Used, How It Is Traded and Where to CheckCDS: an insurance-like promise for when a company cannot pay back

A CDS is a derivative in which protection against a borrower's default (such as bankruptcy) is bought and sold. The buyer pays a fixed coupon, like a guarantee fee, at regular intervals, and the seller settles when a credit event occurs at the reference entity. Trading is mainly over the counter between financial institutions, and JSCC, the clearing house of Japan Exchange Group, has cleared CDS since July 2011. Based on publications from the exchange group, the Bank of Japan, the FSA and the BIS, this feature explains the mechanism, uses, trading flow and where to check prices and outstanding amounts.

Key points

• Mechanism: during the contract the buyer pays a fixed coupon (usually quarterly). If a credit event such as bankruptcy, failure to pay or restructuring of debt is recognised for the reference entity, the seller makes the agreed settlement. Terms are about 1 to 10 years, with 5 years the most common. It looks like a guarantee or credit insurance, but the buyer does not need to hold a claim on the reference entity
• Settlement example (JSCC): A holds JPY 1 billion of company C's bonds and buys 5-year protection at 2% a year, paying JPY 20 million every year. If C fails and the bonds are worth JPY 300 million, under cash or auction settlement the seller pays A the face value minus market value, JPY 700 million. Setting the value through an ISDA-run auction has been standard since 2009
• Uses: hedge the credit risk of loans or bonds without selling them; take on the credit risk of a company with no bonds outstanding; take the credit-risk selling side without holding loans or bonds; read the spread (the CDS price) as a gauge of creditworthiness. Japan's bond market has no repo market, and CDS is described as almost the only way to build a credit short position with reasonable liquidity
• Trading flow: mainly bilateral trades between financial institutions under the ISDA Master Agreement and credit derivatives definitions. The most liquid product is iTraxx Japan, an index of 40 Japanese companies (a new series on March 20 and September 20). In JPX's example, with notional JPY 100 million and a 100bps fixed coupon, buying at a 110bps spread (price 99.52%) means the buyer pays the net of the upfront JPY 480,000 and accrued interest JPY 194,444, i.e. JPY 285,556, then JPY 250,000 of coupon each quarter. Closing at 130bps by an offsetting trade returns a net JPY 1,136,667
• Clearing and size: when JSCC steps in between seller and buyer and assumes the obligations, each party no longer bears the counterparty's credit risk individually. The assumption is made once a week, processed over Tuesday to Thursday and established at 16:00. Eligible trades must meet conditions such as being yen-denominated with notional of JPY 100 billion or less. In the Bank of Japan's regular report, the notional of credit derivatives (OTC) at end-June 2026 was USD 1.0 trillion (+68.9% from the previous period)

What to do in practice

• To follow price movements, check JPX's "Markit iTraxx Japan - today's spread" (index). Single-name prices are published by information vendors, and index prices also appear in the market column of Nikkei (JSCC Q&A)
• For market size and practice, see the Bank of Japan's Regular Market Report on Derivatives Transactions (major Japanese dealers, twice a year), the FSA's OTC derivatives transaction information, JSCC's clearing statistics, and BIS statistics for global amounts
• If you receive an explanation of a CDS or a product that embeds CDS, confirm the reference entity, term, settlement method (physical, cash or auction) and counterparty credit risk, and consult a financial instruments business operator or an expert if necessary