Changes agreed by the major dealers in April to restrict CDS trading to four coupons – of 25 basis points, 100bp, 500bp and 1,000bp – came into effect on June 22 in preparation for the move to central clearing next month, but trading since then has not been completely restricted to those coupons.
"We've seen a range of coupons trading – not just 100bp and 500bp, but 300bp and a small amount of 750bp," said one senior credit trader at a top dealer. "We've found we're among a number of institutions who have been making markets at 300bp."
The original agreement between the dealers envisaged that the 300bp and 750bp coupons would be used predominantly to re-coupon old trades, but left room for manoeuvre among the dealers. "One thing we agreed on was that dealers should be free to trade whatever they want to trade – nobody is suggesting you can no longer do a trade at 363bp for example, or make markets around whichever coupon you want," said the dealer.
In North America, single-name CDSs have been limited to just two fixed coupons of 100bp and 500bp since April – an arrangement some market participants would have preferred to replicate in Europe.
"My view, which is fairly common on the buy side, is that the fewer coupons the better, as it leads to simplicity and transparency," said Jeffrey Kushner, European chief executive at London-based asset management firm BlueMountain Capital Partners. "Fewer coupons, with complete transparency around pricing, will create a more liquid market, with non-core credit participants more likely attracted to using credit derivatives as part of their overall trading strategies. More coupons would likely lead to more coupon rolls and a more opaque market, which in turn could create arbitrage opportunities for market-makers and scare off non-core participants."
But dealers contend that a larger number of coupons is healthy for the market. "Some people would be happier if no-one was doing anything apart from 100bp or 500bp because it would make life operationally neater, but we certainly think the CDS is too powerful a product to be dumbed down and we have no interest in narrowing the range of coupons we can trade on," said the dealer.
Ultimately it will be a matter for the clearing houses to decide. With just four weeks to go until the July 31 deadline agreed with the European Commission for central clearing of CDSs to begin, dealers will only be able to trade at coupons that are accepted by the clearing houses.
Market participants are also busy analysing the details of the so-called 'small bang' protocol, due to open for adherence on July 13, another crucial element of the drive to central clearing, which would integrate restructuring as a credit event into the auction settlement process.