The banks behind iBoxx and Trac-x have announced that they have finally signed a letter of intent to merge the two indices. The indices will be merged globally, although the North American CDS indices will be run by a different company from the European and Asian cash and CDS indices.
In Europe the merger involves the banks behind Trac-x – JPMorgan and Morgan Stanley – joining iBoxx to form a CDS index called Dow Jones iTraxx and a cash index called Dow Jones iBoxx. In the US merger, JPMorgan and Morgan Stanley will join the CDS IndexCo, a company set up by the banks behind the iBoxx CDX index in preparation for the merger.
Raymond Sagayam, a senior vice president in credit trading at Swiss Re, says the merger of the two indices should allow the combined index to better represent the underlying default swap market. Sagayam adds that following the merger, he expects to see an increase in the level of trading activity for this index.
According to Charles Longden, head of credit trading at ABN Amro, the increase in liquidity resulting from all the banks trading one index is unlikely to be able to reduce the cost of trading much further – both legacy indices frequently trade at a 1bp bid-offer spread. But he suggests the concentration of volumes in one index should allow the banks to complete larger trades. What’s more, the increase in liquidity should filter through to lower costs in the tranched indices or futures on the index.
Dow Jones will continue to conduct the marketing and licensing of the default swap indices and will be responsible for the selection of names in the index. It has not yet been decided how names will be selected: whether each bank will supply Dow Jones with its CDS trading figures or provide a list of names that they would like to be included. The former ensures that the names in the index are the most frequently traded but banks are wary of their rivals obtaining their trading figures.
But, when asked about the iTraxx banks’ preferred method, Andrew Palmer, global head of credit derivatives marketing at JPMorgan, says: “With an independent firm in the middle, there is more flexibility and less chance of those numbers getting out.”
The indices are most likely to be merged on the next roll dates, when the names in the indices are updated to continue to represent the most liquid in the default swap market. The next roll in Europe will be June, and September in the US.