ITraxx

Last updated

iTraxx (Thomson Reuters Eikon code 'ITRAXX'; Bloomberg code 'ITRX') is the brand name for the family of credit default swap index products covering regions of Europe, Australia, Japan and non-Japan Asia. Credit derivative indexes form a large sector of the overall credit derivative market. The indices are constructed on a set of rules with the overriding criterion being that of liquidity of the underlying credit default swaps (CDS).

Contents

The group of indices was formed by the merger in 2004 of the Trac-X indices created by J.P. Morgan & Co. and Morgan Stanley and the iBoxx CDS indices created by Deutsche Bank, ABN Amro and IBoxx.

History

Credit default swap indices originated in 2001, as did synthetic credit indices, when J.P. Morgan launched the JECI and Hydi indices.( Nolan & Sproehnle 2011 ) [1] Then Morgan Stanley's Credit desk (under Annabel Littlewood) launched Synthetic TRACERS.( Nolan & Sproehnle 2011 ) "The two banks subsequently merged their indices under the Trac-X name in 2003.( Packer & Suthiphongchai 2003 , p. 82)

In parallel, ABN AMRO and Deutsche Bank teamed with iBoxx to launch the iBoxx CDS indices in February 2003. These indices were the first to have an independent calculation agent in an index provider (and not an investment bank trading the underlying). In 2004, Trac-X and iBoxx merged to form CDX in North America and iTraxx in Europe and Asia."( Nolan & Sproehnle 2011 ) The iTraxx suite of indices are owned, managed, compiled and published by Markit, who also license market makers. Markit administered the CDX family of indices and acting as the calculation agent for the iTraxx indices. In November 2007 Markit acquired CDX and iTraxx. By 2011 Markit owned and managed "the Markit iTraxx, Markit CDX, Markit iTraxx SovX, Markit iTraxx LevX, and Markit LCDX families of CDS indices as well as the Markit iBoxx cash bond indices."( Nolan & Sproehnle 2011 )

By 2011 Markit iTraxx and Markit CDX index trade volumes exceeded US$70 billion a day. They had a "net notional outstanding over US$1.2 trillion." In 2011 Markit iTraxx and Markit CDX index traded almost 50% of the market in single name credit derivatives.( Nolan & Sproehnle 2011 )

On 25 February 2013 ICC launched iTraxx instruments for dealer-dealer and client clearing. [2]

Market

Credit default swap indices allow an investor to transfer credit risk in a more efficient manner than using groups of single credit default swaps. They are standardised contracts and reference a fixed number of obligors with shared characteristics. Investors can be long or short the index which is equivalent to being protection buyers or sellers.

In 1996 the outstanding notional value of credit derivatives (credit default swaps (CDSs)) was $40 billion. [3] By the end of 2001 it was approximately $1.2 trillion. By 2004 it was expected to be $4.8 trillion. Credit default swaps (CDSs) accounted for roughly 45% of the overall credit derivatives market in 2002.( Packer & Suthiphongchai 2003 , p. 79) [3] [4]

In 1997 there were three kinds of CDSs: corporate, bank and sovereign. CreditTrade was one of the major trading platforms for credit derivatives in 2003. ( Packer & Suthiphongchai 2003 , p. 79) [1]

Creditex was the first inter-dealer broker to offer electronic CDS trading in 2004. [5]

Sovereign CDSs, which benefited from the standardisation of contract form and definitions in 1998 and 1999 as well as successful execution in the case of recent defaults, were considered the most liquid credit derivative instruments in emerging markets. Particularly as their liquidity increases, sovereign CDSs had the potential to supplement and increase efficiency in underlying sovereign bond markets. [6]

Between 2004 and the first half of 2007, the creation of credit derivatives indexes, credit default swap indexes, which essentially involve investors selling credit protection on a group of companies, was one of the factors that helped to drive spreads tighter.( Barley 2008 ) [7] Since 5 February 2008 the index spread widened by 25 basis points to a record high just above 110 basis, 60 basis points wider than 1 January 2008 and 90 basis points higher than they were prior to the credit crisis, when basis points were at all-time lows. At 110 basis points it would cost "110,000 euros a year to insure 10 million euros of debt against default." By mid-February 2008, as complex credit instruments unravelled, credit derivatives indexes in Europe set repeated new record highs. The Markit iTraxx Europe index ITRAC5EA=GFI had displaced the iTraxx Crossover index ITCRS5EA=GFI, which was made up of 50 mostly "junk"-rated companies. The Europe index sharply underperformed the iTraxx Crossover index ITCRS5EA=GFI.( Barley 2008 ) [7]

Trading

The most widely traded of the indices is the iTraxx Europe index, also known simply as 'The Main', composed of the most liquid 125 CDS referencing European investment grade credits, subject to certain sector rules as determined by the IIC and also as determined by the SEC. There is also significant volume, in nominal values, of trading in the HiVol and Crossover (also referred to as Xover) indices. HiVol is a subset of the main Europe index consisting of what are seen as the most risky 30 constituents at the time the index is constructed. Crossover is constructed in a similar way but is composed of a min of 40 and a max of 50 sub-investment grade credits. Also traded are iTraxx Sector indices: NonFin (non-financials), SenFin (senior-financials) and SubFin (sub-financials).

The constituents of the indices are changed every six months, a process known as "rolling" the index. The roll dates are March 20 and September 20 each year. For example, Series 13 was launched on March 20, 2010, with a maturity of June 20, 2015 for the 5-year contract. Other maturities for Europe and Crossover are 3 year, 7 year and the 10 year, whilst the NonFin, SenFin and SubFin only trade at maturities of 5 and 10 years.

Trading in iTraxx CDS contracts predominantly occurs in the over-the-counter (OTC) market. However, as of February 25, 2013, the IntercontinentalExchange (ICE) began offering central clearing of iTraxx products. [8] Furthermore, as part of the Dodd-Frank financial overhaul, the Commodity Futures Trading Commission has mandated central clearing of most iTraxx products for entities subject to its jurisdiction beginning April 25, 2013, though the relevant compliance date depends on the size of the entity trading iTraxx products. [9]

Related Research Articles

In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the underlying. Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets.

In finance, a default option, credit default swaption or credit default option is an option to buy protection or sell protection as a credit default swap on a specific reference credit with a specific maturity. The option is usually European, exercisable only at one date in the future at a specific strike price defined as a coupon on the credit default swap.

<span class="mw-page-title-main">Credit default swap</span> Financial swap agreement in case of default

A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting. The buyer of the CDS makes a series of payments to the seller and, in exchange, may expect to receive a payoff if the asset defaults.

The International Swaps and Derivatives Association is a trade organization of participants in the market for over-the-counter derivatives.

A credit default swap index is a credit derivative used to hedge credit risk or to take a position on a basket of credit entities. Unlike a credit default swap, which is an over the counter credit derivative, a credit default swap index is a completely standardized credit security and may therefore be more liquid and trade at a smaller bid–offer spread. This means that it can be cheaper to hedge a portfolio of credit default swaps or bonds with a CDS index than it would be to buy many single name CDS to achieve a similar effect. Credit-default swap indexes are benchmarks for protecting investors owning bonds against default, and traders use them to speculate on changes in credit quality.

<span class="mw-page-title-main">Intercontinental Exchange</span> American exchange and clearing house company

Intercontinental Exchange, Inc. (ICE) is an American company formed in 2000 that operates global financial exchanges and clearing houses and provides mortgage technology, data and listing services. Listed on the Fortune 500, S&P 500, and Russell 1000, the company owns exchanges for financial and commodity markets, and operates 12 regulated exchanges and marketplaces. This includes ICE futures exchanges in the United States, Canada and Europe, the Liffe futures exchanges in Europe, the New York Stock Exchange, equity options exchanges and OTC energy, credit and equity markets.

A Constant proportion debt obligation (CPDO) is a type of credit derivative sold to investors looking for exposure to credit risk. A CPDO is normally embedded in a note rated by a credit rating agency. CPDOs employ dynamic leveraging in a similar way to Credit CPPI trades.

<span class="mw-page-title-main">Asset-backed securities index</span>

An asset-backed securities index is a curated list of asset-backed security exposures that is used for performance bench-marking or trading.

A central clearing counterparty (CCP), also referred to as a central counterparty, is a financial institution that takes on counterparty credit risk between parties to a transaction and provides clearing and settlement services for trades in foreign exchange, securities, options, and derivative contracts. CCPs are highly regulated institutions that specialize in managing counterparty credit risk.

Markit was a British financial information and services company with over 4,000 employees, founded in 2003 as an independent source of credit derivative pricing. The company provides independent data, trade processing of derivatives, foreign exchange and loans, customised technology platforms and managed services. The company aims to enhance transparency, reduce financial risk and improve operational efficiency. Its client base includes institutional participants in the financial marketplace. On 12 July 2016, Markit and IHS Inc. merged in an all-stock merger of equals to form IHS Markit. IHS Markit later merged with S&P Global on 28 February 2022.

The loan credit default swap index (LCDX) is a loan-only credit default swap index created by CDS Index Company (CDSIndexCo). The LCDX index is a tradeable index with 100 equally weighted underlying single-name loan-only credit default swaps (LCDS).

A synthetic CDO is a variation of a CDO that generally uses credit default swaps and other derivatives to obtain its investment goals. As such, it is a complex derivative financial security sometimes described as a bet on the performance of other mortgage products, rather than a real mortgage security. The value and payment stream of a synthetic CDO is derived not from cash assets, like mortgages or credit card payments – as in the case of a regular or "cash" CDO—but from premiums paying for credit default swap "insurance" on the possibility of default of some defined set of "reference" securities—based on cash assets. The insurance-buying "counterparties" may own the "reference" securities and be managing the risk of their default, or may be speculators who've calculated that the securities will default.

IHS Markit Ltd was an information services provider that completed a merger with S&P Global in 2022. Headquartered in London, it was formed in 2016 with the merger of IHS Inc. and Markit Ltd.

The Clearing Corporation is "a Delaware corporation owned by 17 stockholders, many of whom represent the world-wide derivatives marketplace participants and market makers."

iBoxx

iBoxx is a financial services division of IHS Markit that designs, calculates and distributes fixed income indices. iBoxx is overseen by IHS Markit Benchmark Administration Limited, which is regulated by the Financial Conduct Authority and is an authorized benchmark administrator under the UK Benchmarks Regulation. IMBA UK's benchmark administration activities have been conducted in compliance with the IOSCO Principles for Benchmarks since 2014.

LCH is a British clearing house group that serves major international exchanges, as well as a range of OTC markets. The LCH Group consists of two subsidiaries: LCH Ltd based in London and LCH SA based in Paris.

A Swap Execution Facility (SEF) is a platform for financial swap trading that provides pre-trade information and a mechanism for executing swap transactions among eligible participants.

In April and May 2012, large trading losses occurred at JPMorgan's Chief Investment Office, based on transactions booked through its London branch. The unit was run by Chief Investment Officer Ina Drew, who later stepped down. A series of derivative transactions involving credit default swaps (CDS) were entered, reportedly as part of the bank's "hedging" strategy. Trader Bruno Iksil, nicknamed the London Whale, accumulated outsized CDS positions in the market. An estimated trading loss of $2 billion was announced. However, the loss amounted to more than $6 billion for JPMorgan Chase.

ICE Clear Credit LLC, a Delaware limited liability company, is a Derivatives Clearing Organisation (DCO) previously known as ICE Trust US LLC which was launched in March 2009. ICE offers trade execution and processing for the credit derivatives markets through Creditex and clearing through ICE Trust™. ICE Clear Credit LLC operates as a central counterparty (CCP) and clearinghouse for credit default swap (CDS) transactions conducted by its participants. ICE Clear Credit LLC is a subsidiary of IntercontinentalExchange (ICE). ICE Clear Credit LLC is a wholly owned subsidiary of ICE US Holding Company LP which is "organized under the law of the Cayman Islands but has consented to the jurisdiction of United States courts and government agencies with respect to matters arising out of federal banking laws."

A bespoke portfolio is a table of reference securities. A bespoke portfolio may serve as the reference portfolio for a synthetic CDO arranged by an investment bank and selected by a particular investor or for that investor by an investment manager.

References

  1. 1 2 Nolan, Gavan; Sproehnle, Tobias (30 June 2011). "Credit Derivatives Indices: Methodology And Use". Index Universe.
  2. ↑ ICE Clear Credit: CDS Client Clearing Overview (PDF) (Report). July 2013.
  3. 1 2 Credit Derivatives Report 2002 (Report). British Bankers’ Association. September 2002.
  4. ↑ Packer, Frank; Suthiphongchai, Chamaree (December 2003). "Sovereign credit default swaps" (PDF). BIS Quarterly Review. Bank of International Settlements. Retrieved 4 August 2013.
  5. ↑ "Innovation in global CDS execution". IntercontinentalExchange (ICE). Archived from the original on 2012-10-15. Retrieved 2013-08-07.
  6. ↑ Emerging market credit derivatives (Report). JPMorgan. November 2001.
  7. 1 2 Barley, Richard (12 February 2008). Quentin Bryar (ed.). "Factbox:Five facts about the iTraxx Europe index". Reuters. Retrieved 4 August 2013.
  8. ↑ "CFTC's Division of Clearing and Risk Announces Revised Compliance Schedule for Required Clearing of iTraxx CDS Indices". February 25, 2013.
  9. ↑ "CFTC Issues Clearing Determination for Certain Credit Default Swaps and Interest Rate Swaps". November 28, 2012.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.