A type of credit derivative transaction under which the credit protection buyer purchases credit protection from the credit protection seller on a pre-agreed amount of credit exposure (the notional amount) to a reference entity. The reference entity can be a corporation, a sovereign, or any other form of legal entity. CDS take many forms and may be "written on" (that is, the credit protection covers) a basket of reference entities or an index, which are more common than single-name CDS written on a single reference entity.

In return for the credit protection provided by the CDS, the credit protection buyer pays an agreed fee, usually on a periodic basis, to the credit protection seller. Generally, if a credit event involving the reference entity occurs during the term of the CDS, the credit protection seller pays an agreed amount to the credit protection buyer, usually corresponding to the outstanding periodic payments of principal and interest remaining under the reference obligation.

While CDS were originally developed to provide credit protection against a borrower or debt obligor default, they also provide investors with the ability to speculate on the creditworthiness of an entity or basket of entities.

Many CDS are now subject to mandatory clearing and exchange trading under Title VII of the Dodd-Frank Act (see Legal Updates, Final Clearing Determination for CDS and Interest Rate Swaps Issued by CFTC and MAT Summary: CFTC Swap Exchange-trading Mandates and Effective Dates).

For more information on CDS, see Practice Note, Credit Derivatives: Overview (US).