Credit Derivatives Start Trading on Eurex

FRANKFURT—Germany-based international derivatives exchange Eurex, will debut the world's first exchange-traded credit derivatives contract tomorrow, Tuesday, March 27. Eurex officials say the new offering will allow the exchange to further leverage growth of the over the counter (OTC) markets.

According to Peter Reitz, member of the Eurex executive board, several banks are still in a testing phase for the futures, but it will have price providers on the exchange on Tuesday. "We are currently still talking to potential market participants, given that most of the people we are talking to in the credit derivatives haven't traded futures before," he says. "They're going through the process of assimilation with the respect to how they will technically link up to the market."

The global credit derivatives market experienced significant growth over the last 10 years, from approximately $1 trillion in 1996 to more than $20 trillion in 2006, according to a British Bankers' Association report. Mehtap Dinc, senior product expert, Eurex, says the main driver of this growth is the increasing need for standardized products among the growing number of participants.

Eurex will start trading in credit index futures with three contracts: iTraxx Europe five years, iTraxx HiVol five years and iTraxx Crossover five year indices. The iTraxx Europe index is an equally weighted portfolio of the 125 most liquid European investment grade credit default swap (CDS) entities and is provided by International Index Company (IIC). The iTraxx HiVol index is an equally weighted portfolio of the 30 entities with the highest spread from the iTraxx Europe index. The iTraxx Crossover index is an equally weighted portfolio of 45 European sub-investment grade entities.

"We have observed a strong interest in the market for all three credit futures. With our Eurex iTraxx futures suite customers can manage their credit risk at lowest cost with all the advantages an exchange-traded product offers," says Eurex CEO Andreas Preuss.

Dinc says the new release will replicate the risk structure of an OTC credit default. "The trigger mechanism for the credit futures contracts will be the official protocol of the IICC," she says. "This will be the only trigger mechanism for a credit event in relation to the credit future contracts. Once a credit event occurs there will be a mechanism that will provide the market participants with the possibility either to keep the exposure in the reference entity or to get out of that exposure."

The product will be cash settled, with reference to the iTraxx index values of IIC. In the case of a credit event, cash settlement of the single name entity will be made with reference to the ISDA CDS protocol.

"The underlying of our futures products is seen as CDS [credit default swap] baskets with a fixed credit spread and a predefined termination date," Dinc says. The contract will be based on the five-year series, with a fixed coupon and semi annual maturity dates in March and September.

The Eurex iTraxx Europe futures contract will be supported by designated market makers, ensuring liquidity from the start, Eurex officials say. Trading on Eurex will involve Eurex Clearing as central counterparty thereby reducing the counterparty and systemic risk and adding to the benefits the product will offer to users.

The contract value has been set at €100,000 ($133,000). The tick size is set at 0.005 percent translating into €5 ($6.64) per tick. It will be quoted in percent with three decimal places.