Disparity expected in the target market for US and European LCDS indices
As talks continue among dealers over the make-up of proposed new credit default swap indices referencing their respective leveraged loan markets either side of the Atlantic, it appears the focus of the new products will - initially at least - diverge. LCDX, the new North American Leveraged Loan index - which is scheduled for launch in or after October - is understood to be being designed to facilitate standardised tranches in the same way as the CDX tranche market, thereby broadly targeting structured credit investors.
It is expected that LCDX will reference between 75-100 underlying loans, selected by liquidity in the same manner as the CDX Investment Grade Index, which is enough to provide sufficient diversity for tranching. The index will also be a non-cancellable five year bullet that will trade on price and will almost certainly be cash rather than physically settled. So, LCDX will not exactly reflect the underlying loan market and is therefore likely to be less appealing to the existing single name cash investor base.
"Designing LCDX to appeal to structured credit investors is a bold move and is in contrast to other index markets such as the ABX Home Equity index and the planned European Leveraged Loan index, iTraxx LevX, which are structured in ways that reflect the underlying cash markets, which means that they do not necessarily facilitate structured credit investments," says Michael Hampden-Turner, Structured Credit Strategy at Royal Bank of Scotland.
LevX is scheduled to be launched later this year, but precise details of the index constituents have not yet been confirmed. David Mark, CEO of the International Index Company, nevertheless points out that it will initially be targeted at market participants and will therefore reflect the current make up of the European market. He says: "Obviously, as those participants change the index will evolve alongside the market."
As Pierre Emmanuel Juilliard, head of Structured Finance, AXA IM, explains, there are still challenges in Europe even though the leveraged loan market is now big in volume terms, having grown exponentially in recent years - the number of issuers is still smaller than in the US. Equally, the US has benefited from the earlier introduction of cash indices, making the market more liquid and accessible to a wider range of investors.
Consequently, Juillard adds: "I expect that LevX will be more for interbank loan participants than structured credit investors more broadly, while the reverse is likely to be true with the US index. However, the European index will, sooner rather than later, become the way for a broader range of investors to have access to the asset class, because we are seeing more and more demand from large institutions to have access to leveraged loans."
