Desk Mergers Increase Convergence
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Desk Mergers Increase Convergence

The growing trend among firms to merge their credit bond and derivatives desks has caused the two instruments to shadow each other more closely and reduced the number of relative-value opportunities. ABN AMRO (DW, 6/2), Deutsche Bank (DW, 7/14), Merrill Lynch (DW, 7/16) and Salomon Smith Barney (DW, 8/4), have all merged elements of their desks during the summer and several firms, including JPMorgan and Goldman Sachs, already have combined desks. This has caused the most obvious relative-value plays to be arbitraged away. That said, there is still a possible silver lining, Klaus Toft, co-head of credit derivatives quantitative strategies at Goldman Sachs in London, believes that as liquidity improves a whole range of relative-value trades that are popular in the interest-rate swaps market, such as curve trades, will be available.

Kai Seeger, senior credit derivatives trader at ABN AMRO in London, said convertible bonds and default swaps follow each other more closely than cash bonds because convertible bond arbitrage funds are using credit-default swaps to hedge the credit risk and these bonds tend to be the cheapest to deliver in the event of default. Atish Kakodkar, v.p. in the credit derivatives research department at Merrill Lynch in London, added, more convertible bond arbitrage hedge funds have started to buy protection in the last month as credit qualities have deteriorated and the deltas on the bonds have plummeted.

"This is here to stay," said Guy America, European head of credit-default swap trading at JPMorgan in London. He added that the tracking of bonds and default swaps is partially attributable to a decrease in liquidity as investors are on vacation. "In illiquid times you get a lot of people expressing views in the same way." When liquidity improves the tracking will decrease as there are fundamental differences, such as it is hard to short bonds in the repo market, he explained.

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