Index infighting

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An instrument that allows investors to trade the US credit market has been launched under the iBoxx brand as a rival to Trac-x. But the move has sparked angry behind-the-scenes accusations not only between the backers of iBoxx and Trac-x, but also within the separate camps themselves.

The launch of the US iBoxx product – iBoxx.CDX.NA.IG (or credit default exchange, North America, investment grade) – was announced on October 15. As with Trac-x, it allows investors to buy or sell exposure to a basket of equally weighted investment-grade credits via the default swap market. The idea is that investors can use the product, a basket-linked note, as a proxy for the credit market.

Deutsche Bank is understood to be the leading bank behind the US iBoxx instrument with ABN Amro, Barclays Capital, Bear Stearns, Citigroup, Credit Suisse First Boston, Goldman Sachs, HSBC, Lehman Brothers, Merrill Lynch, and UBS all having signed up to trade the product.

Until now, there has been no competition in North America to JPMorgan and Morgan Stanley’s Trac-x product. In Europe, an iBoxx branded product, launched by ABN Amro and Deutsche Bank, has been trading since February. And since JPMorgan and Morgan Stanley merged their respective Jeci and Tracer products to create Trac-x in April, there has been strong competition between the two products’ providers.

Both have attempted to persuade as many banks as possible to join as market makers. And many banks have agreed to sign up for both instruments as a way of hedging their bets – regardless of which wins as the instrument of choice for trading the credit market, they will be trading it.

However Trac-x’s recent monopoly in the US has led to accusations from the other banks that Morgan Stanley and JPMorgan have been abusing their positions.

In Europe, JPMorgan and Morgan Stanley have been forced to take a consultative approach to negotiations with other potential market makers for fear of losing them to the rival iBoxx product. But in the US the two banks have adopted a far more ‘take it or leave it’ approach. Depending on who you speak to, this attitude is either a case of poor communication, according to JPMorgan and Morgan Stanley, or excessive demands, according to some of the other market makers on Trac-x.

The criticisms have focused on two areas: the licensing agreement that all users of Trac-x must sign, and the way in which reference entities are included or dropped from the index. Traders say the Trac-x licensing agreement forces them to use the documentation stipulated by JPMorgan and Morgan Stanley, and that it requires them to seek specific permission before carrying out trades based on Trac-x, such as options on the index. According to a trader at one of the banks backing the new iBoxx product: “The terms that Morgan Stanley and JPMorgan have been demanding were unacceptable.”

Furthermore the fact that Morgan Stanley and JPMorgan can decide which names are retained or dropped from the index whenever it is rebalanced has led to worries about transparency. According to a trader at another bank behind iBoxx: “The main reason for the launch of iBoxx was that customers and dealers felt they were in the dark about what was going on [in Trac-x]. Not everything happening on Trac-x was open and transparent.

Lee McGinty, head of credit derivatives strategy at JPMorgan, rejects such accusations: “The reason that JPMorgan and Morgan Stanley insist that all banks use the same documentation for options on the index and tranched Trac-x is to improve liquidity. If everyone is trading under different documentation, liquidity will be hampered and so will the market.”

The two Trac-x banks have laid down rules regarding what products can and cannot be offered under the Trac-x name “only to stop banks creating completely unrelated products and calling them Trac-x, such as an equity index. All additional products dealer banks wanted to offer have been included in the licensing agreements,” says McGinty.

In response to the accusation that the two Morgans have maintained a tight grip on the names that go in, McGinty says this is a no-win situation – “damned if you do and damned if you don’t,” he says. “The composition of the credits within Trac-x is completely rules-based – the 100 most actively traded are included. To make this as representative as possible we allowed any bank to add their trading figures to the total, but of course no bank wanted to hand that over.”

To tackle the criticisms of transparency and control, JPMorgan and Morgan Stanley signed over the Trac-x index to Dow Jones in October. As a result all participating banks will provide credit default swap trading figures to Dow Jones, which will be responsible for maintaining the index and agreeing what products can be produced under the Trac-x brand.

Lisa Watkinson, global product manager for credit default swaps and credit indexation products at Morgan Stanley in New York, admits: “Some institutions had been frustrated by aspects of the licensing agreement, but we moved to allay those worries some time ago. We have addressed the other concern, about the composition of the index. We had been talking to Dow Jones before the new iBoxx product was announced, so it wasn’t a direct response to that, but it’s fair to say we expedited the agreement so that people would accept we are striving for a more open architecture.”

Ironically, the agreement with Dow Jones in part created some of the tension between JPMorgan and Morgan Stanley on one side and the banks trading Trac-x. According to Tim Frost, head of credit trading and research at JPMorgan in London: “With Dow Jones in the works, we introduced a new contract for the intellectual property rights; we thought this was the kind of thing an independent index provider would require.” Those property rights were then put into the licensing agreement, which other banks thought was constraining. Frost adds: “The discontent was exacerbated in the US when a large number of names in Trac-x were changed, which irritated a number of dealers on the product.”

Deutsche Bank and iBoxx promptly capitalized on the discontent with the launch of their US iBoxx product. But their methods have raised hackles.

According to sources at Deutsche Bank and JPMorgan, on October 9, a week before the launch of the US iBoxx product, Deutsche Bank’s head of credit trading, Rajeev Misra, personally telephoned JPMorgan’s Frost. Misra told Frost that Deutsche Bank was prepared to end the rivalry between Trac-x and iBoxx in Europe. In the interests of liquidity, Deutsche Bank was prepared to discuss various options and a meeting was proposed.

As a result of the phone call, on October 14 Frost visited Misra at Deutsche Bank, at the other end of London Wall. During these talks the idea of merging the two products was discussed and the idea of adopting the name iTrac-x was even floated by Deutsche staff. However, the following morning a press release was sent out announcing the launch of the iBoxx tradable instrument for the North American market.

The reason behind Misra contacting JPMorgan for conciliatory talks is unclear. Misra was unavailable for comment. However a spokesperson for Deutsche Bank told Credit there was never any intention of merging iBoxx with Trac-x.

Trouble at the mill

The iBoxx launch has also managed to rile banks within the group backing the product. Staff at Lehman Brothers are understood to be “spitting bullets” over the way iBoxx has been launched in the US.

iBoxx announced the launch of its tradable US instrument along with the names of the banks backing the deal. But two days before this press release, iBoxx announced that it was launching a US fixed-income index to compete with the existing indices. As a result, the feeling within Lehman is that by signing up to iBoxx, the bank has implicitly endorsed the launch of a new fixed-income index which will compete head to head with its own.

How the launch of a competing tradable credit product will affect liquidity in the market is open to question. Morgan Stanley’s Watkinson does not believe it will have a negative effect on the trading of Trac-x. “I don’t believe the market wants two indices, and I don’t think it will take liquidity away from us,” she says.

Brad Poprik, co-head of the North American structured credit trading desk at Deutsche Bank, unsurprisingly takes a different view. “The major focus of people who want to trade in this market is to get an open, liquid index and to feel comfortable that it best represents the CDS market,” he says. “Whether one index will get more liquidity than the other will depend on the dealers. We think in the near term there will be demand for both indices, but we believe iBoxx is going to be the new benchmark.”

A more objective observation by a buy-side user of Trac-x is: “The question is how many of these instruments can the market handle. When there were five it was ridiculous. But whether it is better to have one index or two is a much harder question to answer.”

Tranched iBoxx

Since the launch of the US iBoxx product, iBoxx has announced the ability to trade tranched versions of the European iBoxx Diversified Index, its European basket-linked note. The new tranched index will be under the name triBoxx.

So far five banks have signed up to quote prices on triBoxx in unfunded (CDS) format using standardized documentation and tranching: ABN Amro, Barclays Capital, Citigroup, Deutsche Bank, Dresdner Kleinwort Wasserstein and SG Corporate & Investment Banking. With the adoption of agreed documentation it increases the likelihood that a similar product will be launched for the US iBoxx.

The standard tranches quoted will be 0–3%, 3–6%, 6–9%, 9–12% and 12–22% slices of the iBoxx Diversified. In addition, it is expected that members of the iBoxx CDS group will quote prices on other tranches of the iBoxx Diversified upon request.

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