Russia CDS trading booms following sanctions

Fri Aug 8, 2014 8:48am EDT

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LONDON, Aug 8 (IFR) - Trading in Russian sovereign CDS has almost doubled since the start of the year, as US and EU sanctions have steadily ramped up pressure on the Russian economy.

Net notional on Russia CDS - a broad measure of market exposure - climbed 83% in January to US$10.1bn in late July, making it now the sixth largest CDS contract in the world.

Sovereign CDS is now one of the most liquid proxies for traders looking to hedge or take outright short positions on Russia. Shorting the ruble and Russian equity exchange-traded funds have also proved to be popular ways to bet against the Russian economy.

Russian CDS spreads have been volatile since the Ukraine crisis escalated in March and the US and European Union announced their first round of sanctions. Five-year spreads spiked to a high of 296bp after the first round of sanctions were announced, and then again in May before cratering to a trough of 166bp in late June.

Spreads have rocketed once more since the MH17 air disaster and the ensuing sanctions imposed by all sides, and now trade at around 270bp. Yields on 10-year government bonds are currently 9.85%, their highest level in almost five years.

Strategists at JP Morgan noted the boom in Russia CDS outstanding was reflected in BIS figures from the end of the first quarter this year, which showed US$163bn of foreign bank exposure to Russia via "credit commitments" and "guarantees extended", which includes selling CDS protection. This comes on top of US$209bn foreign bank claims on Russia.

"US and UK banks account for 80% of the US$139bn of 'guarantees extended', which to large extent reflects CDS protection sold on Russian entities. This is because it is primarily US and UK banks who engage in CDS trading," the strategists wrote in a recent report.

However, the strategists noted that this overstated the banks' exposure through CDS to Russia as the figures are reported on a gross rather than a net basis.

Participants say a decent chunk of the demand for Russia CDS is likely coming from banks' own credit valuation adjustment desks - risk managers that hedge banks' derivatives counterparty risk to Russian firms.

But a lack of alternative liquid Russian proxies means that sovereign CDS is likely to appeal to traders across the market looking for a broad hedge or to take an outright short position.

The only other Russian contracts in the CDS market of note include Gazprom with US$1.7bn net notional outstanding, the recently-sanctioned banks Sberbank (US$463m) and VTB (US$630bn), Rosneft (US$506m), Russian Agricultural Bank (US$1.1bn) and Kazkommertsbank (US$196m).

The JP Morgan strategists said both Russian ETFs - which have seen two months of consecutive outflows of around US$400m - and the ruble remain vulnerable due to short speculative positioning. The ruble has depreciated to around 36.5 against the dollar - its weakest level since before the first round of sanctions were announced and the Central Bank of Russia stepped in to defend the currency. (Reporting By Christopher Whittall, editing by Helen Bartholomew)

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