More than three quarters of U.S. institutions say counterparty risk in credit default swaps (CDS) represents a serious threat to global financial markets, and think another major financial institution to will go under, according to a new study by Greenwich Associates.

Following the collapse of Bear Stearns the firm launched a study of 146 institutions in North America and Europe to investigate how fears of counterparty risk were affecting institutional investment and trading strategies. It found that almost 85% of U.S. institutions see CDS counterparty risk as a serious threat to global markets. Institutions in Europe are more sanguine; with more than 55% describing CDS counterparty risk as a significant danger.

Most of the institutions surveyed believe another major financial firm will fail as a result of the ongoing crisis in global markets, Greenwich said. Nearly 60% of survey respondents say they expect to see another major financial firm collapse within the next six months, and another 15% think it will happen in six to 12 months.

“Only 27% of the institutions think there will not be another casualty along the lines of Bear Stearns,” says Greenwich Associates consultant Frank Feenstra. “If you are looking for a silver lining in these findings, it seems that most institutions think we are currently in the most dangerous period for global financial services firms. Perhaps if the markets can make it through the next six months, the level of pessimism may begin to subside.”

Concerns about counterparty risk have caused institutions to cut back on their use of CDS. Among fixed-income survey participants that employ CDS, 62% say increased counterparty risk has caused them to limit their use. The most common method of managing counterparty risk is to trade only with the most financially sound banks and broker dealers. Almost 65% of participants also say they try to limit the concentration of exposure with a single counterparty. About one-third of participants say they make use of cross-collateral arrangements and 5% say they use exchange products for hedging.

Institutions in general support efforts to reduce counterparty risk in the credit default swap market through the establishment of a centralized clearing entity, Greenwich said. Three quarters of the institutions say they believe the establishment of such an entity would be effective in mitigating CDS counterparty risk.

Additionally, nearly 80% of the institutions participating in the survey say their banks have tightened margin or collateral requirements since the outbreak of the global credit crunch. “The survey results indicate many of the banks widely viewed as being hit hardest by the credit crisis have been the most aggressive when it comes to tightening the margin and collateral requirements imposed on their trading clients, but even banks that have emerged relatively unscathed have tightened terms,” says Greenwich Associates consultant Peter D’Amario.

Of the institutions reporting that their banks have imposed stricter requirements, the majority — nearly 65% — say the change has not had a significant impact on their trading activities. However, more than a quarter of these institutions say the new requirements have caused them to reduce their trading activity.