Growth of index-linked credit default swaps trading has surpassed that of single-name CDS trading, according to a Fitch Ratings report. Index products are becoming increasingly popular with investors seeking to broaden their exposure and enhance liquidity. Market participants say the popularity of index products could even be luring investors away from trading single names.
Fitch used trade data from inter-dealer brokers GFI Group and Creditex, representing a small slice of the market to analyze market trends. It found that trading in index products more than doubled in 2005. Trading volume in single-name CDS, by comparison, grew 80%. However, there were still three to four times more single-name contracts traded last year compared to index trades, according to Fitch's analysis.
"There appears to have been a greater increase in the trading of index products over single-name CDS," said James Batterman, an analyst at Fitch. "This is possibly because investors desiring broad exposure can get that exposure through the use of index products rather than single-name CDS. Trading in index products is often very liquid and efficient, and there are a variety of different index products available."
The report found that the volume of single-name CDS trading in certain industries more than halved in 2005, compared to 2004. These sectors include aerospace, banking, finance and telecommunications. Batterman said this could partly be due to the growth in the trading of indices, which could be cannibalizing some of the trading of single names.
The trading of index-linked CDS on asset-backed securities is also growing. Stephen King, head of synthetic ABS CDOs at Barclays Capital, said certain market participants in the asset-backed market have turned to indices as an alternative to single-name CDS. "It is quite clear that the index has replaced single names for certain participants who are seeking liquidity over specificity. The index narrows peoples' trades to a specific subset of the universe of single-name CDS and thereby maximizes liquidity in the index. Because everyone is trading on the same terms, naturally there are more buyers and sellers for the index."
But single-name trades appear to be the method of choice still. "Those parties that are looking to trade over the short term, where liquidity is a priority over protection on a specific set of names, have moved to the index. But, overwhelmingly, parties still want to buy or sell protection on specific single names," said King.
