Credit derivatives volumes soar


By Paul J. Davies and Gillian Tett
Financial Times, London
Thursday, March 1, 2007

Trading volumes in credit derivatives markets hit almost unprecedented levels this week as the market turmoil that continued to infect equities led to wild gyrations in the cost of protecting corporate debt against default.

Between E125 billion and E150 billion of trades on European indices alone have been executed in the past three days, according to estimates from banks.

Marcus Schüler, head of integrated credit marketing at Deutsche Bank, one of the biggest trading houses for credit derivatives in London, said index market volumes in the first four days of this week amounted to more than E150 billion.

"That's three times the average weekly volume," he said. "It depends on tomorrow's levels whether it will be a record week." Volumes for the US market are thought to have increased in a similar dramatic fashion.

The figures highlight the importance of credit default swaps -- which provide a kind of insurance against non-payment in corporate debt -- and the indices that are based on them, as a gauge of investor sentiment towards the credit world.

Analysts and traders said losses from the blow-out in spreads -- or risk premiums -- particularly on junk-rated derivatives indices of the past few days would have been widely shared between investment bank traders and asset managers involved in the market.

This is in part because almost everyone in the market has been making the same "long" bets -- adding exposure to credit risk with the idea that the outlook was not going to worsen any time soon. "Both [Wall] Street and clients have been caught long," said one trader. "With the moves on Tuesday, some peoples' year would have been wiped out."

The most violent movements in recent days have focused on the iTraxx Crossover Index, which measures the danger of default on risky corporate bonds. Last week this traded at about 169 basis points, implying that it costs E169,000 to insure against default on E10 million of debt. In the past few days the price rose over 235 basis points and on Thursday moved 204 basis points and 230 basis points.

Those who have suffered the most pain are likely to be those who entered the sector most recently.

Stephen Dulake, analyst at JPMorgan, said one problem was the "style drift" that had encouraged a number of investors not familiar with the junk-rated market to jump on -- and then off -- the bandwagon.

"There has been a lot of new entrants to the world of trading iTraxx Crossover in particular," said Mr Dulake. "It seems that high-grade traders and bank [proprietary trading] desks are as culpable as anyone."

* * *

Help Keep GATA Going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at GATA is grateful for financial contributions, which are federally tax-deductible in the United States.