Further, unlike an IRS contract, the payoffs in a CDS to the protection seller are the “fees” for assuming a contingent liability and not actually an income. The accounting treatment of recognizing fees as income, while the contingent liabilities are relegated to “below the line”, might prompt participants reckon the CDS as a pure income generating strategy, oblivious to the embedded risks. 32.
While the facility of buying protection even when not having an insurable interest increases the universe of protection buyers thus increasing the market liquidity, it may result in adverse incentives. If the lenders have protection via CDSs, they may have more to gain from the company failing than they would gain if the company survives.