By Danielle Robinson
NEW YORK, Feb 24 (IFR) - Wall Street banks, having failed to
make any money out of electronic bond-trading platforms, are now
focusing on ways to benefit from new regulations enforcing the
central clearing of credit default swaps.
A Greenwich Associates survey released last week revealed
that only 1% of investment-grade corporate bond investors used
single-dealer platforms, such as Goldman Sachs's GSessions, last
Nevertheless, banks such as Citigroup and Barclays are still
keen to discover ways to offset derivatives and trading profits
lost due to stricter regulations, and are hoping there will be a
jump in single-name CDS use once the SEC rules later this year
that they need to be centrally cleared.
"We think that moving CDS credit clearing to a central
counterparty gives rise to a more specific use of CDS as a
rating enhancement tool," said Peter Aherne, head of North
American capital markets, syndicate and new products at
The use of single-name CDS has dropped by about a third
since the crisis, according to Morgan Stanley, to around US$1trn
outstanding in net notional terms. Banks and other users have
found it less useful to hedge against credit risk in an
environment of record low default rates.
But Morgan Stanley's Sivan Mahadevan, head of US credit
strategy, believes CDS use will actually increase because of the
"Thanks to the Volcker Rule, market-making and general
risk-mitigating activities in banks may motivate additional use
of CDS," he said.
Barclays has become the first committed market-maker on
MarketAxess's central limit order book electronic trading
platform for single-name CDS.
"We are hopeful that these market structure changes lead to
increased liquidity in the product," said Bob Douglass, head of
credit electronic trading at Barclays.
Citigroup, meanwhile, has developed a bond product with
eBond Advisors that aims to capitalize on the significant
decline in counterparty risk once single-name CDS is centrally
The product involves an issuer putting language into the
documents of a new bond issue that will allow those securities
to become enhanceable by attaching CDS protection after launch.
The end result is a single-CUSIP instrument that has the
potential for an improved rating.
"The real value created by the eBond enhancement is the
creation of a 'single' instrument for trading, rating, financing
and accounting," said Richard MacWilliams, managing partner at
The eBonds can be enhanced as much or as little as the
investor wants, can be traded as a single entity, or can be
split into the two separate pieces. On a Triple B instrument,
for example, 50% enhancement would imply a Single A rating, 80%
Double A and 100% Triple A.
Among the potential users are bank treasury departments,
currently swimming in excess liquidity and investing mostly in
Treasuries and MBS.
Banks have been increasingly turning up in high-quality bond
issues at the short end of the curve to boost investment returns
in a low interest rate environment.
The eBond tool could conceivably enable them to purchase
lower-rated bonds and enhance them up to the point where they
are only exposed to rate risk, but still provide a higher yield
than a government security.
The biggest potential users are investors who do not dabble
in CDS or are restricted from buying lower-rated bonds.
"If you can figure out a way to package the insurance into
the actual bond that just turns it into one security, then what
you are doing is opening up the entire world of corporate bond
investors to the use of a product that requires single-name
CDS," said Dexter Senft, co-head of fixed income electronic
trading at Morgan Stanley.
Investors and sellside competitors are generally curious and
will be interested if the tool turns out to be economically
efficient and liquid.
"We potentially would be interested in buying enhanced bonds
because they offer the opportunity to adjust the risk in names
that might otherwise fall out of our acceptable risk profile,"
said Richard Donick, chief investment officer at DCI.
Citigroup now has to find an issuer willing to embed the
eBond language in bond documents. The argument that this could
expand a borrower's investor reach is a hard sell, however, in a
market in which US$7bn-plus book sizes are common.