A swap dealer is a licensed investment broker who buys and sells collateralized debt obligations (CDOs) known as credit default swaps (CDSs). These instruments work similarly to insurance products as the party that purchases a CDS insures a debt instrument owned by the CDS issuer in exchange for regular premium payments. Swap dealers are employed by brokerage firms or investment companies and these individuals may negotiate on behalf of either the issuer or the CDS purchaser.
In many countries, brokers can trade swaps in the same way that other types of securities such as stocks and bonds are traded, although swap transactions are often private; this means that the transactions occur outside stock exchanges. Nevertheless, individuals who negotiate these trades must be licensed to sell securities. To become a licensed broker, an individual must attend a series of training classes that are administered by representatives of the regional or national securities regulatory authority. At the end of the training session, attendees must successfully pass an exam before they can apply for a license. While a swap dealer does not necessarily have to have a college degree, many firms prefer to hire dealers who have degrees in finance, economics or a related topic.
CDS issuers use the money raised from selling swaps to fund lending and other investment opportunities. Therefore, a swap dealer employed by the firm issuing swaps must aggressively market these instruments to investors. The dealer attempts to negotiate the lowest possible premium by proving to the potential investors that the assets being insured are low risk securities. If the CDS purchaser never has to make a payout, then the issuer’s premium payments provide the purchaser with pure profit. In most instances, purchase agreements include a clause enabling the purchaser to increase the premium charge at a later date and the broker is responsible for negotiating the lowest possible price.
Many large investment firms and venture capitalist companies buy swaps issued by various types of businesses. These firms employ dealers who attempt to negotiate hefty premiums so as to maximize the purchaser’s potential profits. Premium prices are contingent upon risk levels and the riskiest swaps normally involve the largest premium payments. A swap dealer has to weigh the risks of pursuing the most profitable premium payments while ensuring the purchaser is not exposed to excessively high levels of risk.
Like most investment brokers, a swap dealer is normally paid on commission. For dealers representing swap purchasers, the commissions are often tied to the premium payments on the swap. Dealers representing swap issuers normally receive commissions that are based on the level of coverage the swap purchaser is willing to provide. In other instances, the brokers receive commissions that are based upon the number of trades that are executed within a specific time period.