Global credit funds & CLO's
July 2020 | Issue 225
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July 2020 | Issue 225
News derivatives
Curves and skews come back into play as CDS volumes swell
Dan_Alderson
Dan Alderson
Deputy Editor
Sayed Kadiri headshot
Sayed Kadiri
Editor
The rapid growth of the CDS market during the coronavirus pandemic has been consolidated in the second quarter, with investors putting on trades not seen in such volume since the 2008 financial crisis.
“Up to 18 June CDSClear has cleared €1.34 trillion notional across all CDS products, roughly 90% of what we cleared in the whole of last year,” says Frank Soussan, global head of CDSClear at clearing house LCH.
In mid-March, at the height of the coronavirus-led market sell-off, single name CDS traded 50 basis points wide of the CDX IG index and this prompted a lot of skew trading, says David Goldenberg, head of US credit derivatives trading for Americas at Credit Suisse.
“Our team was trading from 6am in the morning until the next evening, and sometimes overnight with Asia,” he says. The bank has packaged these trades for investors and Goldenberg believes there is still client interest despite the basis closing to 6-9bp in June.
According to Soussan: “For customers it only makes sense to clear these if they can clear the full trade, and we are the only CCP that offers this for all names in the index.”
Similar to the trading initiative Credit Suisse has undertaken, LCH has helped make skew trades more affordable for investors by clearing them as packages — a change that has implications for the CDS market.
“We have made these trades more efficient by enhancing the framework to cut IM [initial margin] for index basis packages by close to 80%, depending on the index,” says Soussan. “This approach should also be applicable to curve trading and delta hedging options. It’s just a matter of dealers agreeing with clients to clear trades this way.”
Curve trading is another area that has seen a revival, says Goldenberg. “The 10-year point of the IG index is much more liquid today than it was a few years ago and that’s led to a lot of 5/10 year and 3/10 year trades,” he says. In addition, macro funds have increased their involvement in the index market (as these products are cleared), which has created liquidity in long tenors.
According to Goldenberg, increased volume in 10-year CDS has benefited from the tenor’s relative value versus investment grade cash bonds and exchange traded funds, which have a longer effective duration than the traditional five-year CDS tenor.
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“The 10-year point of the IG index is more liquid than it was a few years ago”
David Goldenberg, Head of US credit derivatives trading for Americas | Credit Suisse
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