CDS Index Comes Stateside

April 27, 2007

The fastest growing segment of the derivatives market is scheduled for an index.

U.K.-based Markit Group Limited and CDS IndexCo are close to launching the first credit derivative swap (CDS) index in the United States.

CDS' are a complex and fast-growing type of financial contract that is used by bond buyers to hedge default risk. If a bond goes bust, then the seller of a CDS will repay the buyer the full value of the bond.

The global market for credit derivatives more than doubled last year to cover more than $34.5 trillion of securities; it was the third consecutive year of 100%+ growth. The contracts are the fastest growing corner of the $370 trillion market for derivatives, according to Bloomberg. Despite their widespread use, however, there is currently no established U.S. credit derivatives index. In the U.K., indexes from iTraxx have been around for more than six months. The iTraxx indexes were launched by the International Index Company (IIC), with Markit as the calculation agent.

The new LCDX Index (Liquid Credit Derivative Index) will track prices on credit derivative swaps for U.S. junk bonds. The index has been delayed more than once since its originally scheduled launch date in mid-March, but should begin dissemination within the next couple of weeks, in mid-May.

"The LCDX has been keenly awaited by dealers and institutional investors," a Markit spokesperson said in a statement.

CDS IndexCo is a consortium of 16 banks licensed as market makers for the CDX family of credit derivative indexes. Markit is the index administrator and provider of independent data, portfolio valuations and OTC derivatives trade processing.

Market participants are hoping that the indexes will promote the loan credit default swap market by creating new levels of liquidity, making the market more efficient for current participants and helping to pull in new investors.

The iTraxx LevX was somewhat less complicated than the as-yet-unreleased LCDX, its U.S. counterpart. In Europe, the contract for a credit default swap is simply cancelled when the loan is paid off. However, in the U.S., a dealer poll determines a replacement loan, and this difference made developing a calculation methodology more difficult.

The issues of defaults and data collection also required lengthy consideration. The "what if" scenario of what to do in case of default had to be taken into account, even though such an event would be rare. And, because all loans are not equal in corporate lending, the hierarchies of these loans must be determined as well. Unfortunately, the data is not public information and must be extracted from companies and lenders who have little reason to cooperate.

Despite these obstacles and the delays they caused, Markit and CDS IndexCo expect the newest member of the CDX index family to begin calculation soon.

UK-based Markit Group Limited and CDS IndexCo are close to launching the first credit derivative swap (CDS) index in the United States.

CDS' are a complex and fast-growing type of financial contract that are used by bond buyers to hedge default risk. If a bond goes bust, the seller of a CDS will repay the buyer the full value of the bond.

The global market for credit derivatives more than doubled last year to cover more than $34.5 trillion of securities; it was the third consecutive year of 100%+ growth. The contracts are the fastest growing corner of the $370 trillion market for derivatives, according to Bloomberg. Despite their widespread use, however, there is currently no established U.S. credit derivatives index. In the UK, indexes from iTraxx have been around for more than six months. The iTraxx indexes were launched by the International Index Company (IIC), with Markit as the calculation agent.

The new LCDX Index (Liquid Credit Derivative indeX) will track prices on credit derivative swaps for U.S. junk bonds. The index has been delayed more than once since its originally scheduled launch date in mid-March, but should begin dissemination within the next couple of weeks, in mid-May.

"The LCDX has been keenly awaited by dealers and institutional investors," a Markit spokesperson said in a statement.

CDS IndexCo is a consortium of 16 banks licensed as market makers for the CDX family of credit derivative indexes. Markit is the index administrator and provider of independent data, portfolio valuations and OTC derivatives trade processing.

Market participants are hoping that the indexes will promote the loan credit default swap market by creating new levels of liquidity, making the market more efficient for current participants and helping to pull in new investors.

The iTraxx LevX was somewhat less complicated than the as-yet-unreleased LCDX, its U.S. counterpart. In Europe, the contract for a credit default swap is simply cancelled when the loan is paid off. However, in the United States, a dealer poll determines a replacement loan, and this difference made developing a calculation methodology more difficult.

The issues of defaults and data collection also required lengthy consideration. The "what-if" scenario of what to do in case of default had to be taken into account, even though such an event would be rare. And, because all loans are not equal in corporate lending, the hierarchies of these loans must be determined as well. Unfortunately, the data is not public information ,and must be extracted from companies and lenders who have little reason to cooperate.

Despite these obstacles and the delays they caused, Markit and CDS IndexCo expect the newest member of the CDX index family to begin calculation soon.

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