Indices: ERMBX adds more volatility

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By:
Rachel Wolcott
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Anticipation of the much-discussed but now postponed launch of the European residential mortgage-backed securities index (ERMBX) is behind violent swings in spread levels on single-name credit default swaps on RMBS tranches. Markit, ERMBX’s owner, announced that the index’s debut has been delayed because of market volatility. That volatility, in fact, has been caused by buyers of protection on single-name CDS referencing prime RMBS AAAs, say market participants.

The ERMBX.UK, which is designed to reference synthetic UK prime RMBS, has been under discussion for a while, and some dealers have been preparing to make a market in the product by buying protection on single-name RMBS CDSs. If the ERMBX was launched in order to make a market with the large macro funds that wouldn’t want to do single-name trades, dealers needed to be axed. Through buying protection on the underlying names at the moment when or if the index launches, these trading desks can sell protection on the index to a hedge fund that wishes to buy protection on the UK consumer, for example.

"At the moment this activity has caused a great deal of volatility," says William Davies, director and senior RMBS and consumer ABS analyst at Deutsche Bank in London. "In the last few weeks alone, CDS spreads [on single-name UK RMBS] seesawed from about 100 basis points to 160bp and back in to about 120bp. You can see the obvious trading opportunities led to a number of desks voting yes for the ERMBX index. But we expect even those for the index are now likely to be under pressure from syndicate desks and bank treasuries not to have an index launching at possibly the weakest point in the market."

Dealers point to Goldman Sachs as being behind the protection-buying spree. "A lot of [activity] is coming from Goldman, which doesn’t have much of a cash business to be affected by the mark-to-market pressure," notes one dealer. Spreads did come in to the 120 level around the time traders realized Goldman was the end protection buyer behind many of the trades, but spreads have since gapped out again.