An innovative approach to benchmarking Canadian credit risk

Key takeaways:

• Indices in the FTSE Canada Bank Credit Spread Index Series are transparent and designed to be replicable, with individual security holdings, prices and spreads disclosed daily
  
• The design of the indices balances capacity, tradeability and the accuracy of spread measurement
  
• The FTSE Canada Bank Credit Spread Index has been designed to underlie a listed, cash-settled futures contract in the form of the new Canada Credit Futures from TMX

Points of differentiation:

• The index series has been designed with the input of a variety of Canadian fixed income market participants, including TMX, CanDeal, buyside firms and fixed income dealers
  
• The FTSE Canada Bank Credit Spread Index’s security and weight allocation policy is designed to prioritise liquidity, simplicity and transparency
  
• The index is designed to reflect market perceptions of bank credit risk, serving as a useful risk tool for corporate bond market participants

What does our research mean for investors?

Corporate bonds’ credit spreads are often used as leading indicators for economic activity because of the relationship between the quality of borrowers' balance sheets and their access to external finance.

Within the corporate bond sector, banks’ credit spreads merit particular attention. Given the high issuance levels and relatively higher liquidity of bank-issued corporate bonds, market shocks or periods of credit spread compression are usually captured more quickly in banks than in the broader corporate bond universe.

An index that quickly reflects market perceptions of bank credit risk therefore serves as a valuable tool not just for corporate bond investors, but for the broader financial markets. Such an index can serve not just as a benchmark for broader credit market conditions and as a key risk measure in asset allocation models, but also as a pricing tool in other financial contracts (such as listed derivatives).