The spread between Australian credit derivatives and bonds has widened because of banks structuring synthetic collateralized debt obligations and that's creating opportunities to arbitrage credit default swaps. "Traders have been actively taking advantage of opportunities available in Western Mining and Australia Gas Light Company (AGL)," said Jim Fingleton, associate director of fixed income atSG Australia. As CDO structurers look to diversify out of U.S. and telecom debt, demand for Aussie exposure has increased which has meant synthetic CDO structurers have been selling protection. The end result is that the market has become skewed toward sellers.
"Everyone's willing to offer protection cheaply," according to Bob Bosse, v.p. credit derivatives at Westpac Banking Corporation in New York. Several firms in Australia have been taking advantage of the cheap protection, buying the credit default swap and then buying the underlying bonds. This enables the trader to hedge out the credit risk on the name and carry the difference between the credit default swap and the underlying bond. Fingleton said AGL is typically tightly held in Australia but negative news in recent weeks has seen a dramatic increase of AGL bonds floating in the market, which have allowed local players to purchase the bond and buy credit default protection at a cheap rate. Pierre Katerdjian, global swap trader at Deutsche Bank in Sydney, said a typical trade would be to buy the bond at LIBOR plus 85 basis points and buy protection at LIBOR plus 61bps. This gives a carry of 24bps. Katerdjian continued that the rates on the bonds and default swaps should come into parity over time.
