A European loan credit-default swap index may launch in a matter of weeks, but some dealers are saying it will be stillborn because there is insufficient liquidity in single-name LCDS. Year-to-date trading volumes of over USD4 billion have been quoted by dealers promoting the business in Europe. One active trader, however, told DW the figure is inflated and two-way liquidity is non existent.
The index, tagged iTraxx LevX, is actually being touted as a way of bolstering liquidity because it will allow easy exit from positions, create relative value and capital arbitrage opportunities and make structured products easier to hedge. "A nascent single-name market shouldn't be a limitation to bringing this to the market," said Richard Stuart-Reckling, credit product manager at Morgan Stanley in London. Morgan Stanley, alongside Dresdner Kleinwort, is viewed as one of the LCDS market's key promoters.
Other traders, however, believe the launch of an index is premature because there is a lack of players willing to take the short side of trades and no Street-wide consensus on standard European documents. "This index is not being driven by demand pull; it is a supply push," said one head of loan trading at a U.S. house in London.
There also appears to be division in Europe over adopting documents currently used by at least five dealers including Morgan Stanley, Dresdner, Deutsche Bank, Lehman Brothers and Barclays Capital. The crunch is over whether the documents should include an option for the protection seller to call the contract if the underlying loan is restructured. One trader called for European dealers to take up the recently agreed U.S. Loan-Only CDS document, which places more restrictions on cash-settling the loan. It is believed at least three other houses, among them JPMorgan, are working on a separate document.
No exact date has been set for the launch because dealers are still finalizing the structure, said Tobias Sproehnle, iTraxx product developer at the International Index Co. in Frankfurt, which will be administering the index. At present, LevX consists of the 35 most liquid high-yield European corporate loan CDS and comprises two sub-indices; senior or first lien and subordinated or second lien. Trading will be based on price rather than spread to match the underlying loan.
