Wednesday, October 3, 2012

Six observations about index CDS markets

Once again it's time to clear up some misperceptions about the CDS markets. In particular, let's take a look at CDS index trading. The chart below shows one-month daily trading volume averages for the various CDS indices.

1-month daily average CDS index volumes ($bn; source: JPMorgan/MarkIt) 

Here are some observations:

1. CDS index trading is dominated by corporate unsecured credit, particularly investment garde: IG CDX and iTraxx Main.

2. European corporate credit trading is dominated by banks (followed by telecoms), while the US actively traded credits tend to be non-banking firms. That's why iTraxx Sen Fin (senior EU bank credits) is so popular. Barclays and Banco Bilbao Vizcaya Argentaria for example have been at the "top of the charts" in Europe, while the US market shows the highest volumes in GE and HP.

3. Sovereign indices, such as SovX are a fraction of the corporate market. Emerging markets CDX has more volume than the Western European SovX.

4. The market for CDS on senior secured debt (corporate loans), the so-called LCDX, is dead. This market was popular in 2007/8 when people sold protection on LCDX and bought protection on HY CDX thinking that in a crisis secured paper will outperform unsecured bonds - which would be reflected in the spread between the two. But these investors were wrong, as LCDX protection widened out just as fast as HY CDX as leveraged loans took a major beating. Since then the market on loan CDS has all but disappeared.

5. The municipal bond CDS index, MCDX never really took off and shows little improvement. As much as Markit wants this index to be used to hedge municipal bond portfolios, that is just not happening on any material scale.

6. Asset backed indices are mostly the left-over structures from the pre-crisis era. These include ABX (see discussion) and CMBX. They are used for spec trading as well as to hedge ABS and mortgage books. But even in that space users prefer corporate credit indices such as CDX IG and CDX HY to hedge their portfolios. Liquidity trumps increased basis risk these days.


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