It’s a sign of the times that Markit, which compiles the iTraxx and CDX European and US corporate CDS indexes, on Monday announced the launch of the first global family of sovereign credit default swap indices.
Historically, the trading of sovereign CDS was confined to emerging markets, reflecting credit risks associated with the government debt of these countries. But, as Markit explains, an actively traded CDS market in industrialised sovereigns has emerged from the financial crisis and higlights growing investor concerns over the solvency of developed economies (witness the recent hysteria about Britain’s sovereign debt).
Hence, from September, four new indices of credit default swaps will run alongside CDS for individual countries, which are already traded.
As the FT reported on Monday, there is some debate about how – and to whom – the new indices will be most useful. With governments around the world taking on increasing levels of debt to counter the downturn and fund bank bail-outs, these CDS have become important for investors as a way of speculating on or hedging sovereign credit risk.
Markit expects the sovereign indices will be used by traditional CDS investors, but also, perhaps, by traders of government bonds. Debt managers, responsible for issuing government bonds, say sovereign CDS indices could help gauge a country’s credit risk. But some government bond analysts said that an index of countries, which may have very different risk profiles and debt levels, may prove less useful than buying individual sovereign CDS.
Of the four new indices, the two that Markit expects will attract the most liquidity are the iTraxx SovX Western Europe index, which will track the CDS of 15 countries western European countries, and the Markit iTraxx CEEMEA index, comprising 15 countries in central and eastern Europe, the Middle East and Africa.
Two other indices will track the CDS of the G7 countries, and the CDS of countries in Asia, Europe, Latin America, the Middle East, Africa and North America.
The irony of it all – that sovereign CDS indices are being created to address investor concerns about public debt, which is ballooning as developed countries flog huge amounts of it to investors to shore up their banks and economies – has not been lost on some commentators.
To help clean up the mess and unfreeze the credit markets, many European and world governments have been borrowing massive amounts of money and injecting it into their economic systems in order to add liquidity. Unfortunately, the massive spending and borrowing are putting the credit quality of many these same countries into jeopardy, producing an unusual turn of events as CDS contracts are now being used to protect against default in those very countries which had too many companies with dangerous levels of CDS exposure.
Now, not only can you trade CDS contracts to protect yourself against a country defaulting, but soon you will be able to trade a more diversified basket of sovereign CDS contracts. Profitable? Maybe. Of course if there is another massive default, I am not sure who will be left to bail out this market if spending continues at current levels. There is only so long you can solve a problem caused by too much debt by taking out additional debt. But, look on the bright side. At least now you can trade it. I guess financial innovation never sleeps.
Related links:
Markit to launch first global family of sovereign CDS – Markit
S&P warns UK over high debt level – FT