Swap Gauge Expands in Latest Effort to Revive Derivatives MarketJohn Glover
Gauges investors use to hedge against losses or speculate on the credit quality of Europe’s financial companies have been expanded in the latest effort to revive the $14.8 trillion credit derivatives market.
Benchmark indexes of credit-default swaps now protect 30 of the region’s banks and insurers, up from 25 previously tracked. That’s the most since they were created and follows two successive expansions of Europe’s high-yield corporate benchmark.
Markit Group Ltd., which manage the indexes, is seeking to boost liquidity in measures that have seen a 23 percent reduction in outstanding volumes over the past year. Credit-default swap contracts were overhauled last year to better protect holders of financial debt by explicitly insuring against losses imposed as part of government rescues of failed lenders.
“By increasing the index members you might get more volume and that should help with liquidity,” said Gregory Turnbull Schwartz, a money manager in Edinburgh at Kames Capital, which manages about $78 billion. “The financial indexes aren’t particularly liquid, though the senior is better than the sub.”
Contracts on Rabobank Groep, Danske Bank A/S, Mediobanca SpA, Svenska Handelsbanken AB and Swiss Re AG were added to the senior and subordinated versions of the Markit iTraxx Europe Financial Index and to the region’s investment-grade benchmark, according to a statement on Markit’s website.
The amount of debt protected by the senior measure fell about 10 percent in the past year to $14.7 billion and the subordinated gauge fell 48 percent to $1.97 billion, according to the Depository Trust & Clearing Corp. A gross $1 trillion is now outstanding across all credit indexes, down from $1.3 trillion a year ago, DTCC data show.
The expansion makes the indexes “more attractive” to investors, Chris Telfer, a money manager at ECM Asset Management in London, wrote in an e-mail. “CDS as a product is not what it once was.”
The index is being enlarged as the latest series of benchmarks measuring the cost of protecting corporate debt around the world start trading. New gauges are created every six months when companies are added or dropped depending on their ratings, cost of protection and ease of trading.
Measures of swaps on companies in Europe, Asia, Australia and Japan are rolling into their 23rd series. The 24th version of the Markit CDX North American Investment Grade Index starts Friday.
The new measure of senior financial debt cost 65 basis points at 10:40 a.m. in London, according to data compiled by Bloomberg. That compares with 62 basis points for Series 22 at the close yesterday. The new subordinated gauge cost 139 basis points, up from 130.
Five consumer companies were removed from the previous version of the Markit iTraxx Europe Index of swaps on 125 investment-grade borrowers to make room for the financial additions. Three other companies changed in the investment-grade measure, while five companies were substituted in the high-yield benchmark, Markit said.
Trading is declining in bond and derivative markets as tighter regulation and tougher capital requirements encourage dealers to cut back on businesses that require them to use their balance sheets.
Banks are reducing bond holdings, particularly of those that rarely trade, making it harder for buyers and sellers to find each other, the Bank for International Settlements said this week. Deutsche Bank AG stopped trading credit-default swaps tied to individual companies last year, saying regulations make the business too costly.
Banks and insurers have also reduced borrowing, issuing about 560 billion euros of bonds denominated in pounds and in the single currency last year, compared with 701 billion euros in 2011, data compiled by Bloomberg show. The tally fell to as little as 487 billion euros in 2013, the data show.
The index expansion will better reflect holdings of financial bonds, said Abel Elizalde, a strategist at Citigroup Inc. in London. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.
“The problems with liquidity in credit-default swaps are in many ways driven by the same factors that impair liquidity in the cash market,” said London-based Mitch Reznick, co-head of credit at Hermes Fund Managers, which oversees $44.5 billion. “They are the unintended consequences of regulatory-driven bank deleveraging that undermines banks’ abilities to be the liquidity providers.”