IntercontinentalExchange Group Inc., owner of the world’s largest credit-default swap clearinghouse, is close to offering futures on the most active derivative indexes.
The new contracts will replicate the lineup of companies included in the investment-grade and high-yield swap indexes owned by Markit Group Ltd., according to a person with knowledge of the plan. ICE, as the company is known, failed in an earlier effort at credit-swaps futures that sought to give investors a way to bet on improving or deteriorating credit markets.
The move to create futures based on swaps has gained steam after the Dodd-Frank Act in the U.S. required most swaps to be backed by clearinghouses, which increases the cost of using the contracts. Futures are typically cheaper to trade than swaps as they require less cash and fewer securities to be held as margin. They could also be used by arbitrage investors who seek to exploit price differences between the swap and future.
ICE, based in Atlanta, will only offer futures on the most recent, or on-the-run, Markit index, said the person, who asked not to be identified because the details of the plan are private.
The company is discussing the contract’s specifics with the dealer banks it needs to support the effort as market makers and with investors and money managers, the person said.
“We continue to gather feedback from credit market participants and look forward to rolling out a new contract in the coming weeks,” Brookly McLaughlin, an ICE spokeswoman, wrote in an e-mail.
The company’s previous effort at credit-swaps futures sought to give investors a directional view of credit markets. The future was based on the next series of Markit indexes that begin trading every six months. By buying or selling the contract on the index before the constituent companies had been named, investors could wager on whether they expected credit conditions to improve or worsen.
That idea was ahead of its time and “largely failed,” ICE Chief Executive Officer Jeff Sprecher said at an investor conference at Goldman Sachs Group Inc. last year.
“We came up with a unique design that was really one step beyond what’s traded today. So it was a giant step,” he said. “We’re going back to the drawing board to figure out what we do in the futures area.”
Among the most popular credit-default swap indexes are the Markit CDX North American Investment Grade Index, comprising 125 companies, and the Markit iTraxx Europe Crossover Index, which holds 60 companies. ICE obtained an exclusive license to use the Markit indexes from the London-based company in 2012.
Credit swaps based on the debt of individual corporations or governments have the unique feature among derivatives of sudden surges in volatility and price as the underlying entity either nears insolvency or fails to pay its debt. When a company in a swap index fails to pay its debt, the holder of the contract is paid a cash amount equal to what the default is determined to represent.
For the futures contract, a default among a member company would result in the owner receiving the same amount of cash as in the scenario for the swap index. The money would be deposited into the margin account for the trade, the person said.
This will allow the swap and futures index price to stay aligned as changes occur to the underlying basket of companies, the person said.
Other attempts to create futures based on credit swaps haven’t caught on with investors. In 2007, the world’s largest banks that buy and sell credit swaps resisted efforts by CME Group Inc. and Eurex AG to offer credit swaps-like futures. That was before the September 2008 failure of Lehman Brothers Holdings Inc., one of the biggest swaps dealers.
In 2010, Deutsche Bank AG, Goldman Sachs and Morgan Stanley held discussions with exchanges including CME Group about creating futures contracts on credit swaps indexes, people familiar with the matter said at the time.