Traders in Tokyo have noticed an increase in dollar/yen switch plays on credit-default swaps in the Japanese interbank market in the midst of quiet trading in recent weeks as traders look to hedge their currency risk as well as exploit mispricing on credits quoted in the two currencies.
In a switch trade a trader buys a credit-default swap on a Japanese name in one currency, say dollars, and then sells protection on the same credit in another currency, in this case yen, looking for an arbitrage in pricing.
Default-swap trading has fallen to about 10 trades a day from 25 at the end of February and traders said this is responsible for the increase in switch trades as traders now have the time to look for arbitrage opportunities. One trader attributed part of the lull in activity to the end of the fiscal year in Japan, which occurred in March, as many end-users have completed hedging.
A credit derivatives trader at a European house in Tokyo said that interest in such transactions has been seen across the interbank market as dealers look to off set their basis risk between dollar and yen-denominated credits. For instance, a credit-link note on a Japanese corporate may be issued in dollars but the underlying bond is denominated in yen, thus creating a need to hedge the basis risk.
Alternatively, he added that dealers are also looking to trade on mispricing between credits in the two currencies, which can lead to a pickup of 5-35 basis points. In a recent example, a trader noted activity on Takefuji Corp., where one bank purchased credit protection at 125bps in yen and simultaneously sold protection at 150bps in dollars from the same counterparty, providing a pickup of 25bps. He declined to name the firms involved in the transaction.
Stephane Delacote, head of credit derivatives at BNP Paribas in Tokyo, said switch trades have also been executed on default-swaps reference to Fujitsu, NTT Corp., and Nomura Holdings.
The typical size of the trades has remained at USD10-15 million, however traders said there is no way of estimating the size of positions individual banks are building up.
