BlackRock’s on a Mission to Save the Credit-Default Swaps MarketNabila Ahmed and Sridhar Natarajan
BlackRock Inc. is leading a push to revive trading in a key part of the credit derivatives market that’s shrunk 57 percent as post-crisis regulations made it costlier to trade.
The world’s biggest asset manager is targeting contracts known as single-name credit-default swaps -- those tied to individual companies and countries. That piece of the market has declined disproportionately because it has been slower to adapt to new standards for trading. BlackRock has had preliminary discussions with banks and other debt investors for a plan that would route trades through clearinghouses intended to curb risks to the financial system.
The push is gaining urgency after Deutsche Bank AG said last year it would exit most of the single-name market because regulations have made the business less profitable. At the same time, investors have gained interest in using swaps again as it becomes increasingly difficult to buy and sell bonds and loans.
“We just don’t want to see another dealer exiting the market,” Supurna VedBrat, co-head of market structure and electronic trading at BlackRock in New York, said in a telephone interview. “We need to figure out ways in which we can make this market work a lot more efficiently.”
With a credit swap, an investor is paid an annual premium for agreeing to insure against the default by a company or government. It’s also a way for firms to hedge against losses as the expectation for defaults increase.
BlackRock’s efforts would bring back a market that regulators blamed for exacerbating the 2008 crisis by allowing investors to amplify bets on debt while spreading the risks across the globe. To prevent a repeat of that, banks are being required to hold more capital backing their trades or to process them through central clearinghouses that are backstopped by their members.
Unlike with swaps tied to indexes, regulators haven’t yet pushed most single-name credit swaps through central clearinghouses. Instead they’ve largely remained bilateral transactions between dealers and clients, requiring higher capital charges under banking regulations. While indexes in the U.S. are overseen by the Commodity Futures Trading Commission, individual contracts are regulated by the Securities and Exchange Commission.
“If we just wait for the SEC, the market could continue to shrink for a few more years,” Eric Gross, a credit strategist at Barclays Plc in New York, said in a telephone interview.
The regulations have increased costs in what had been one of the biggest profit centers before the crisis for dealers in the market, led by banks including JPMorgan Chase & Co. and Goldman Sachs Group Inc. Deutsche Bank is pulling out of most single-name trading while shifting resources to more profitable businesses, spokeswoman Michele Allison said in November.
Net wagers in single-name swaps have declined to $686 billion from more than $1.58 trillion in late 2008, when the Depository Trust & Clearing Corp. first started reporting outstanding positions in the market.
More recently, though, parts of the market have been making a comeback as unprecedented stimulus measures from central banks globally suppress interest rates and increase demand for higher-yielding assets.
Trading in swaps tied to indexes has been increasing. Net wagers on the most-active contract tied to an index of North American investment-grade companies have jumped more than 37 percent in the past two years to $90.7 billion, DTCC data show.
Investors have been lured to the swaps indexes as the global hunt for yield intensifies the competition for allocations on new bond deals and it becomes more difficult to find bonds in secondary markets. That’s in part because banks have scaled back their inventories of the debt to preserve capital.
“This helps you get that credit exposure,” said Kevin McPartland, an analyst at Greenwich Associates in Stamford, Connecticut. “Investors can use it as a hedging tool or even as a way to express their take on the credit even if they aren’t able to source the actual bonds.”
Intercontinental Exchange Inc., which runs the biggest clearinghouse for credit swaps, has processed about $38.3 trillion of index contracts in the U.S., compared with $3.14 trillion for single-name swaps, according to data from the Atlanta-based company known as ICE.
ICE has also been exploring ways to “address increasing capital constraints and boost the single-name market,” Brookly McLaughlin, a spokeswoman for the company, said in an e-mail.
ICE has added 12 investment firms this year to its list of non-dealers that are clearing some single-name contracts, bringing the total number to 30, according to the company.
BlackRock is aiming to have a more detailed plan in place by the end of August on how best to resuscitate the market by clearing more trades.
“The idea is for us to begin with perhaps 10-15 of the most-traded single-name CDS contracts and that will actually get the market going,” VedBrat of BlackRock said. “We are having discussions with all the various constituents that need to be part of the ecosystem. We want to see the product start to clear.”
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