Dealers are close to agreeing on how to tranche the ABX index, a move they expect will lure in a wave of end users who've been skittish about the lack of standardization.
Uniform tranches will give both traditional collateralized debt obligation investors and issuers themselves another way of going long ABS names while saving on the rating and underwriting costs associated with CDOs. The new index would contain 40 underlying reference names, making it more similar to a collateralized debt obligation--which typically hold 50-60 names--than the current indices which consist of 20 names. The plan is to roll out the tranches by year-end, possibly in conjunction with the introduction of ABX 3.
Since the ABX first rolled, dealers have been creating bespoke tranches of various combinations. Some firms, such as Lehman Brothers, Deutsche Bank and JPMorgan, have combined BBB and BBB minus bonds from ABX 1 or 2 and pushed for this to become the standard. But other firms had been combining bonds with different vintages rather than different ratings.
"It doesn't make sense to include different stacks from the same deal if the idea is to create more diversity," noted one trader. "It's certainly confusing if you are trying to hedge with some index under that because you would end up four indices thick," added another.
Combining similarly rated stacks across two vintages looks set to become the market norm. Still up for discussion, however, is the number of tranches in each index.
Markit Group has been involved in the discussion and will look to take on administration of the index. Dealers are currently deciding what law firm to choose to draft the documents and plan to hold a follow up meeting within the next month.
