Glencore Bears Dust Off Forgotten Credit Swaps for Cheap Short

  • Trading in swaps tied to Xstrata surge amid market turmoil
  • Xstrata credit swaps converge with Glencore as risk rekindled

As the investing world rushed last week to sell anything related to Glencore Plc, traders in the credit market turned to an all-but-forgotten derivatives contract in a bid to juice their bets against the commodities giant.

Trading in credit-default swaps tied to Xstrata Ltd., the coal exporter that Glencore bought in 2013, surged six-fold last week as increasing concern the company will struggle to weather the commodities slump prompted investors to search for cheap shorts on other entities within the firm’s empire.

Because the market in Xstrata swaps largely dried up after the takeover -- with credit traders assuming the unit’s debt would eventually disappear -- the cost of hedging against a default by the entity lagged behind, creating a gap of as much as 2.1 percentage points in September. At the height of the turmoil last week, the gap disappeared, meaning that a well-timed trade would have doubled the typical return of a bet against the company, data compiled by Bloomberg and pricing provider S&P Capital IQ’s CMA show.

"Xstrata credit-default swaps offered a cheaper alternative for shorts in the Glencore debt complex,” said Rick Mattila, head of strategy and research at Mitsubishi UFJ Securities International Plc in London. “The two contracts are in theory equivalent.”

The trading shows the depths to which credit traders searched last week for ways to bet against Glencore -- or to protect against potential losses -- as speculation intensified that the firm will have difficulty managing a net $30 billion debt burden amid the worst commodities rout in 16 years. The trades are also shedding light on how a global takeover boom has left a wave of forgotten-about entities that can catch traders off guard when their new owners become perceived as a credit risk.

Banks, hedge funds and other firms in the market wagered $169 million on Xstrata during the week ended Oct. 2, up from an average of $28 million in the six previous weeks, according to the Depository Trust & Clearing Corp. That caused the price of the contracts to surge. And an investor that bought 10 million euros ($11.2 million) of protection against a default on Sept. 28 would have gained 700,000 euros by the next day, Bloomberg and CMA data show. That compares with 344,000 euros for anyone using swaps tied to Glencore.

Charles Watenphul, a spokesman at Glencore in Baar, Switzerland, declined to comment.

There is a rub, however. Because there’s been so little demand for insurance tied to the Xstrata entity, it’s become tougher for investors to trade those contracts, especially in comparison to swaps on Glencore.

The amount of debt protected by credit-default swaps on Xstrata has dropped 60 percent to a net $344 million since the takeover was completed in 2013, while insurance on Glencore debt has climbed 5 percent to $2.1 billion, DTCC data show. Traders bought and sold a gross $2.1 billion of protection on Glencore last week, the second most among companies globally, following Volkswagen AG’s $2.2 billion.

Legacy Debt

“Holders of legacy Xstrata bonds may have chosen to hedge with Xstrata credit-default swap contracts although they have been far less liquid historically,” Mattila said.

Investors grew concerned that Xstrata’s default swaps could be left without underlying securities if the combined company replaced existing loans or issued new debt out of a Glencore entity. Such so-called orphaned contracts aren’t necessarily worthless because companies could always decide to raise funds through old entities later.

Glencore had $36.5 billion of bonds outstanding as of June 30, according to a document on the company’s website. Bonds issued by Xstrata before the merger are guaranteed by Glencore and Glencore International AG under a cross-guarantee structure and rank pari-passu, the document shows.

Since the merger, the cost of insuring Xstrata’s debt averaged 81 basis points less than Glencore’s, according to data from CMA. Swaps on Xstrata surged to within five basis points of Glencore’s on Monday from 205 basis points less on Sept. 4, the data show. Contracts on Xstrata now cost 576 basis points, compared with 592 for Glencore, the data show.

“Xstrata’s debt is guaranteed by Glencore, hence Glencore should trade wide of Xstrata,” said Aritra Banerjee, a credit derivatives strategist at Citigroup Inc. in London.

Peter Grauer, the chairman of Bloomberg LP, the parent of Bloomberg News, is a senior independent non-executive director at Glencore.

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