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Derivatives

Nomura Boycotts Nascent Credit Index

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Japan's Nomura Securities, which has a long-established credit derivatives presence, will not become a market maker in the recently launched Dow Jones iTraxx CJ index due to the inclusion of its name among the reference entities.

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Japan's Nomura Securities, which has a long-established credit derivatives presence, will not become a market maker in the recently launched Dow Jones iTraxx CJ index due to the inclusion of its name among the reference entities. "We won't participate in market-making because our own name is included," said a trader at the firm, who declined to further comment. Some derivatives houses are hesitant about writing credit derivatives on their own name because of how self-referenced credit protection would be dealt with in a bankruptcy.

Credit-default swaps referenced to market makers in the iBoxx European credit derivatives index were originally excluded from the index, but after the merger with TRAC-X and the launch of the iTraxx indices, the consortium decided to include them because there are now so many institutions making markets in the instrument. For example, Deutsche Bank is both a market maker and a constituent of the index. Charlie Longden, global head of market making and structured credit trading at ABN AMRO in London, said the credit-default swaps are ranked by volume and the top names in each sector make up the index. "There are no exceptions," he added. Longden believes that because each institution makes up a small amount of the index the extra counterparty risk is worth having for the increased diversity and market representation.

Jon Jonsson, a director in European credit derivatives strategy at Merrill Lynch in London, said the counterparty risk element is ultimately down to whether the investor is willing to take the risk. He added that in a 125 name index, as is the case in Europe, each entity only makes up 0.8% of the index and therefore it's not going to be hugely relevant. The problem becomes larger as investors start trading the sub-indices and is at its most acute when trading single names.

Dealers noted the issue was discussed with Nomura in conference calls in the run-up to the launch of the index. Despite the Japanese house's request for its name to be pulled out because it said it would be uncomfortable trading its own credit, the market decided against removing the name. "It's a straight-forward methodology and we decided against making an exemption in what is an automated process," said one credit head in Tokyo, noting that the index is comprised of the 50 most liquid names and the Japanese house is included in the list. "It's unfortunate, but we hope that over time they'll change their minds," he continued, noting that it is important to get more players involved in order to boost liquidity.

"Nomura likely did not have internal guidelines or approval to trade its own credit risk," said one market official, noting that guidelines differ from firm to firm. For example rival Japanese house Mitsubishi Securities is actively making markets the index although its credit is also listed.

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