Default-swap spreads on France Telecom have inverted--the first time that has ever happened in the European credit derivatives market--due to demand from hedge funds seeking to buy short-dated protection to hedge credit risk on the company's short-dated convertible bonds. Mid-market three-year protection was 275 basis points Thursday, while mid-market five-year protection was 255bps according to Chris Francis, head of international credit research at Merrill Lynch. Robert McAdie, structured credit analyst at Lehman Brothers in London, added, "This is an interesting phenomenon that is really being driven by hedge funds in the market."
Analysts attribute the inversion, and the overall spread widening in default-swap spreads relative to their cash bond counterparts (DW, 2/11), to a general rise in risk aversion in recent weeks and a concentrated look at accounting practices, which is hurting debt-laden and acquisitive companies such as France Telecom. This is causing hedge funds, which McAdie said now account for 75% of investors in convertible bonds, to buy credit protection to strip out the credit risk. France Telecom has been the most active European issuer of convertible bonds. Also causing the inversion is demand from collateralized debt obligations structurers, which sell five-year protection on liquid names for inclusion in synthetic portfolios leading to tighter spreads for the five-year, according to Francis.