Credit derivatives arose from the demand by financial institutions to hedge and diversify credit
risk, but they have now become a major investment tool as well. Almost all credit derivatives
take the form of the credit default swap, which transfers the default risk of one or more
corporations or sovereign entities from one party to the other. Up until 2004, the majority of
credit default swaps were written on single names, but after the introduction of widely accepted
credit indices in 2004 the major impetus to growth and market liquidity has been credit default
swaps on indices. The major challenges facing credit derivatives in their first years of existence
were resolving ambiguities in reference entities and in definitions of credit events. Since the
introduction of index trading and the widespread entry of hedge funds, the major challenges have
been in settlement after credit events and in addressing operational backlogs that resulted from
increasing numbers of novations. Now that hedge funds are an established part of the market,
the next issue of interest is likely to be whether credit derivatives activity will move to exchanges.