At a mid-March meeting in New York, the 12 banks behind the iBoxx CDX tradable index, the North American version of iBoxx’s credit default swap index, agreed at least five points that look set to herald a merger between iBoxx CDX and its main industry rival Dow Jones Trac-x within a matter of days. But the agreements limit the scope of the merger to just North America.
The five points agreed are as follows: first, any merger should focus on uniting the tradable indices in North America. Second, a global merger should wait until a later date. Third, the name iBoxx, which is associated with a string of both cash and credit default swap indices in Europe, should be dropped in favour of a neutral name. The names Dow Jones and Trac-x are also thought to be unlikely to survive the merger.
Fourth, the banks agreed that they did want JPMorgan and Morgan Stanley – the two owners of Dow Jones Trac-x – to join this new index group. People at JPMorgan and Morgan Stanley involved in the negotiations on a merger declined to comment on whether they would join this new CDX group, however it is understood that both firms are keen to have one standard tradable product. Fifth, the new entity should use one data administrator, understood to be Mark-it Partners, a firm that already calculates the DJ Trac-x index and provides consensus pricing data in the credit market.
In response to the idea of dropping the Dow Jones name, Lars Hamich, executive director global business development at Dow Jones Indexes, says that it is certainly possible, however he cautions against the banks going it alone completely without Dow Jones. “It would be short-sighted of the banks to try to run these indices in-house. I am not sure that an exchange would feel comfortable with that.”
The keen interest of derivative exchanges the Chicago Board of Trade and Chicago Mercantile Exchange in listing these indices for futures trading is understood to have been a strong spur to the banks to produce one index. And according to Hamich, the derivatives exchanges would prefer to see an independent firm with experience in indices, running the licensing and ensuring that clear rules are applied.
The talks were also the result of growing pressure from the buy-side users of these two indices, the banks that trade both products and the inter-dealer brokers to stop the squabbling and start negotiations.
As an example of just how heated the debate had become, on March 10, in an iBoxx CDX press release announcing that Wachovia had joined the tradable index as the twelfth consortium member and seventeenth licensed market-maker, the tradable index confirmed that it was “proceeding with preparations for the first roll of the iBoxx CDX family of indices”, which would start trading on March 22.
According to sources in the two consortia, in response to that release a group of investors – hedge funds, proprietary trading desks and loan portfolio managers – got together and asked the banks behind iBoxx and Trac-x to delay a roll of their products until a merger could be agreed, reportedly regardless of the cost in money or reputation.
In the North American market these indices are rolled every six months to ensure that the constituent names are liquid and representative of the market, a process that can be time-consuming for those using the indices as a hedge for the credit market. A merger that did not coincide with a roll would force a de facto roll, as the two products would again change the constituent names.
iBoxx CDX has since proceeded with the roll but even so bankers behind iBoxx and Trac-x insist a merger is days away. Negotiations over such a merger have been continuing since November when the banks behind the Trac-x index – JPMorgan and Morgan Stanley – approached the members of iBoxx CDX and market-makers in Trac-x. From that, six banks – Bear Stearns, Credit Suisse First Boston, Goldman Sachs, Lehman Brothers, Merrill Lynch and UBS – threw their weight behind a merger.
According to a head of global credit derivatives trading at one of the banks: “It was us responding on behalf of our clients. They would prefer to have one liquid benchmark and a clear place for everyone to go to trade.”
He blames investor reticence to begin using the products on a lack of certainty over which product will survive. “On the high-yield side, neither index has enough liquidity, a lot of people are on the sidelines because investors do not want to invest in an index that suddenly stops trading down the line.”
A source at another of the six banks says: “There is no good reason to have two indices. We have said get together and knock heads and work this out. We’re indifferent about which one emerges, we just want to see one index so the whole market can innovate on the same products.”
Several of the inter-dealer brokers, including GFI and Creditex, are also behind a merger. Sunil Hirani, chief executive at Creditex, says: “What is really important is to have one widely recognised and widely traded instrument. It helps build liquidity and confidence in the market.”
Ian Clague, global head of exotic credit derivatives at GFI in London, agrees: “Liquidity in the index market would be increased by this merger and the same would be true of the indexed tranched market.”
In mid-October 2003, Rajeev Misra, Deutsche Bank’s head of credit trading, and Tim Frost, JPMorgan’s former European head of credit sales, trading and research, met at Deutsche Bank’s London offices to discuss the possibility of a merger – Deutsche Bank is one of the leading banks within iBoxx. These talks collapsed when, on the morning after the meeting, iBoxx announced the launch of the iBoxx CDX North America index (see Credit November 2003).
But a merger again became a possibility earlier this year when on February 17, the six banks approached iBoxx and Trac-x with a proposal for a merger – already being referred to as Letter of Intent One (LRI 1). This proposal was due to be put before a vote of the members of iBoxx on February 27. For it to be passed, it would require a two-thirds majority. Before the vote, a poll was taken of how the votes would fall. Of the 11 banks that were at that stage members – Wachovia had yet to join – seven voted for and four against. Since this voting pattern did not constitute a two-thirds majority, the vote was abandoned.
Since then there have been a number of proposals put forward by both sides, but the banks could reach no consensus until the mid-March New York meeting. A major sticking point is understood to have been whether ownership of the iBoxx cash index should be included in any merger. The banks behind iBoxx CDX that also own stakes in the cash index are understood to prefer this option – ABN Amro, Barclays Capital and Deutsche Bank. Whereas the banks that already have their own cash indices, most notably Lehman Brothers and Merrill Lynch, are understood to prefer leaving the cash index out of the merger.
Given that the cash indices only cover European credit – although there are plans to launch US cash bond indices – the CDX consortium decided to sidestep the issue by leaving Europe out until later. It is hoped that this will provide a boost to talks of a European merger. “It doesn’t make sense to me to split these global indices up into difference pieces,” says Lars Hamich of Dow Jones Indexes. “If the US merger helps to get something going globally then it will be alright.”
Hamich is hopeful that the same pressures that forced a merger in the US will also facilitate one in Europe. “The intensity [of the pressure for one index] in Europe is perhaps not the same as in the US, but I think you have the same pressures and it will be difficult to ignore that.” As with the US, Europe’s two main derivative exchanges are interested in listing tradable credit indices to trade futures and Hamich believes that if the exchanges went ahead without the indices merging then it would split liquidity and make for a lengthy and mutually destructive fight.
For their part, London-based bankers behind both Trac-x and iBoxx have made it clear that they support a merger in the European product.
A banker behind Trac-x tells Credit: “We do want to do a merger and we are very open to a merger.” A source at a bank behind iBoxx says: “We’re all positive and we’re all looking forward to getting together. However, the question of the timing is still wide open.”
According to a banker involved with Trac-x: “A common understanding could emerge in a matter of days, but I’m not sure there will be a quick execution.”
Whereas a London-based banker at one of iBoxx’s backers says: “We certainly see the logic of a merger but it’s not a simple process and it’s not going to happen in a matter of days.”
Despite much of the pressure for a merger coming from the US banks and US users of the indices and despite the departure of Tim Frost, one of the markets strongest proponents of a unified index, it is understood there are talks continuing between Deutsche Bank and JPMorgan regarding a European merger. And while a merger is likely to take more time to implement in Europe, it is still expected to go ahead.