* ICE to launch four CDS futures in May
* Greater sandardisation opens door to listed products
* Market players concerned over new contract design
By Christopher Whittall
LONDON, April 12 (IFR) - Standardisation and electronic
trading for OTC derivatives are helping dealers warm to the idea
of CDS futures, but as four new contracts prepare to launch in
May, many remain sceptical.
Dealers have long been reluctant to support initiatives that
could hurt their swaps profits, while the question of CDS
triggers has been hard to resolve.
Though previous attempts to get CDS futures off the ground
have sputtered, Intercontinental Exchange (ICE) believes there
will be strong interest in its four new contracts based on the
most liquid US and European indices: CDX NA IG, CDX NA HY,
iTraxx Europe (Main) and iTraxx Crossover.
Dealers still express concern over the design of the
contracts, which aim to circumvent potential pitfalls around
credit events, but ICE - which clears USD35trn in gross notional
CDS worldwide - says their new products will show the market's
time has come.
"Dealer support for previous attempts was ambivalent or even
hostile, but now there is a trend towards more futures style
markets," said Peter Barsoom, COO at ICE Clear Credit.
"There are significant players who want to express credit
views but find it hard to do so via swaps," he told IFR. "We
feel that introducing futures will create synergies and
complement the swaps market as well."
BETTER, BUT GOOD ENOUGH?
Previous attempts from Eurex, CME and Liffe to launch CDS
futures never really got off the ground in the pre-2008
financial crisis era.
Without question, the CDS market has come a long way since
those first efforts to create a listed product in the credit
Liquidity has dramatically shifted towards index products,
which have increasingly resembled a standardised, listed market.
In the first week of April, USD77bn of gross notional traded
on the iTraxx Europe Main index - one of the indices ICE is
using for the new contracts - compared to USD26bn in the same
week back in 2009.
Competition is showing signs of ramping up. S&P Dow Jones
Indices launched three new CDS indices on the S&P500 on
Wednesday and has licensed trueEX, an exchange, to create
accompanying futures contracts.
As with futures, the most liquid CDS indices are now traded
electronically. This has compressed bid-offer spreads, eroding
dealer margins and so dampening their incentive to veto futures
products in the process.
Moreover, dealers have to hold more capital against swaps
positions under new regulations, making them less attractive to
trade for capitally-constrained banks, Barsoom said.
But many in the market remain hesitant - and the new
contracts launching next month already have garnered a number of
sceptics and detractors.
"I've always been a big proponent of simplifying the
product, and think if they are able to structure a simple
futures product, it will attract interest," said Tim Gately,
European head of credit trading at Citigroup.
"That being said, I think the jury is still out on whether
this has been accomplished."
Among other gripes, several traders have expressed concern
about the ICE's "when issued" format - meaning investors will
trade futures on an index without knowing the constituents.
Markit reviews its index constituents every six months and
substitutes in names using a rules-based approach.
Yet while there are rarely radical changes - most index
rolls add or subtract no more than 10bp from the previous index
level - some investors still don't like the idea.
"I think it is difficult for anyone to price a security
before knowing what the names are," said one credit hedge fund
"I don't see anyone - buy-side or sell-side - having any
interest in [these futures]," he said.
The ICE believes that "when issued" helps to get round the
tricky issue of CDS triggers and credit events.
ICE's Barsoom conceded there were legitimate questions about
the functionality, but believes the market will get comfortable
with the futures over time.
After all, he said, equity traders trade long-dated futures
contracts on the S&P500 index without knowing the exact make-up
of the index.
Despite the complexity of launching futures in the credit
space, many believe the stars are aligned for a shift to more
Overall CDS volumes may have plummeted following the abrupt
halt of the structured credit boom in 2008, but index trading
has flourished. The four Markit indices ICE has singled out are
by far the most liquid in the market.
Meanwhile, enforced clearing and electronic execution of OTC
derivatives under the US Dodd-Frank Act has led to a debate over
the extent to which futures may grab market share away from OTC
Certainly, there is a clear economic incentive for investors
to trade listed products where possible: traders have to post
five times more margin against swaps than they do against
For investors who want exposure to credit spreads rather
than default protection, futures could well prove a more
"Typically 60% to 75% of initial margin is associated with
jump-to-default risk," Barsoom said.
"If you're not interested in that risk, you're overpaying on
the swap. That's why we created this," he said. "It has a
different economic and risk profile from a swap."