Europe’s top CDS market makers on Wednesday voted to amend the rules governing the Markit iTraxx Crossover index, on the grounds that the existing criteria did not “reflect changed market conditions.”
The Crossover is an index of 50 mostly non-investment grade European companies.
Among other things, the new rules will raise the cut-off level on spreads for companies included in the index by around 200 basis points, Markit said.
Previously, whenever the Crossover “rolled” into a new series - an event which happens every six months - any company with CDS spreads above 1,250bp would have been dropped from the index.
The next series of the index, due for launch on September 22nd, will allow companies trading with up to 25 points up front and a spread of 500 basis points during the last 10 days of August to remain a constituent.
At these deeply distressed levels, which are roughly equivalent to an annual premium of 1,440bp, an investor would have to cough up €2.5m up front plus €500,000 a year to buy a five-year CDS contract on €10m of debt.
Protection sellers demand up front payments to compensate for the perceived risk of the “insured” company defaulting on its debt before the contract expires - i.e, five years looks like a really long time.
There are seven companies in the current series of the Crossover that are quoted in points up front, and at least three of them would not have made in into the September series of the index if the old rules were applied.
Under the new regime, only one - WIND Hellas, a Greek telecoms company - would qualify for ejection.
The Crossover index is a widely-watched barometer of sentiment in the European market for credit default swaps. These changes suggest that the Continent’s big banks - whatever the Pollyanna-esque proclamations of their chief executives - are preparing for a parlous future.
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