The Roll Call is a concise, expert-led discussion presented by LCH CDSClear featuring contributors from S&P Dow Jones Indices and Barclays, focused on the key themes shaping the upcoming September CDS credit index roll.
This session explores:
- The CDS index reconstitution process and the factors influencing constituent changes
- Key developments expected across CDX IG, iTraxx Main and iTraxx Crossover
- The growing influence of AI and hyperscaler-related issuers within credit markets
- Expectations for spreads, investor positioning and relative value opportunities around the roll
Designed as a timely market update, The Roll Call provides perspectives on the developments shaping credit markets and the themes to watch out for as the September roll approaches.
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Welcome back to "The Roll Call," CDSClear's discussion on the upcoming roll.So twice a year, we have index reconstitution.Names go out, names come in, and I'm really pleased to havetwo experts to give us the real meaning and a prelude to what'scoming. So I'm joined by Nick Godek from S&P Dow JonesIndex, and Jigar Patel, who's a director of credit research fromBarclays. So I think clearly there's the technical reconstitution,but this is a real pulse of giving asense to market participants of how credit risk has evolvedover the period since the last roll.But I think one always assumes that everyone really understands themechanics of that reconstitution process, but I think it's always useful to have arefresher. Nick, do you mind just giving us a few high-levelpoints on how you guys make this happen every six months?Absolutely. And thanks Michael, for having me on.There are a number of technical mechanics in terms of how the indices arereconstituted twice a year, but I think you hit it on the head when you talk aboutthe pulse of credit markets. Ultimately, what the CDX and iTraxx roll process ismeant to do is meant to reconstitute the indices such that the lateston-the-run indices include really the pulse of credit markets for theirgiven regions and credit tiers, whatever that may be.Our starting point tends to be the prior on-the-run index.We make removals based on credit events like defaults or bankruptcies, as well ascorporate actions, potential rating migrations out of a given universe.And then entities are included primarily based on their CDS activity throughobservable trading volumes in single names.We find that that tends to be the best indication often of where there's naturalhedging and just general interestin the market. So that's kind of the core way that we include names.And then we also use other supplementary information like notional outstanding andthe cash complex for a given debt issuer, along with trading volumes as well.No, great.In cash, I should say.Yeah. No, thanks. AndI guess for the purposes of today's discussion, we're just going to focus onCDX, iTraxx, and of course the options.So perhaps I'll put the spotlight back on you, Nick.Yep.CDX IG, Series 47, right?Can you give us an overview of what's coming in and what's going out?Absolutely. So we're expecting six names to leave based on inactive issuerreview, where we're removing names with minimal CDS activity,and just general market interest, and entities that are often not expected tocontinue issuing debt in the future.And then we're bringing in six new names with those removed.And in terms of those names coming in, there are two that are quite excitingbecause they continue a trend of adding hyperscaler and AI-related names.Those two expected names are NVIDIA and SpaceX.In the prior roll in March, we saw Meta, Alphabet, andMicrosoft enter the CDX IG index, and already existing in the indexwere Amazon, Oracle,Broadcom, and AMD. So adding all those together, now there's a verymeaningful concentration and exposure to that hyperscaler theme, which is becomingmore important to credit investors in general.We're also seeing an increase in healthcare exposure through the inclusion ofThermo Fisher, as well as Teva Pharmaceutical Industries.However, we are losing one healthcare name with Danaher exiting the universe.And then another theme that we're seeing in addition to the AI thread isrising stars coming in. So names moving from the high-yield universe to IG.Specifically, we're seeing Vistra Operations, Carnival, andthe last one is Teva Pharmaceutical Industries. They're coming in.Great. So, Jigar, I'm going to pull you into this conversation.How do you expect these changes in the rolls to translate into actual spreadlevels?Sure. Well, thanks for having me on, Michael.Thanks.So based on the changes that Nick just went through, we think from a fair value orsum of the parts perspective, that the new CDX IG Series 47 index will trade sevenand a half to eight basis points wider than the current Series 46 index.Now, about two basis points of that is due to the constituent changes that Nickjust described, while the rest of it is due to the longer six-month maturity of thenew Series 47 index.So if these changes are going to translate into the index tradingmeaningfully wider, how do you expect investors to position themselves inresponse to that?Yeah. So this roll is what we would consider to be a steep roll.And by steep, I mean a roll that is expected to trade wider than what we wouldnormally see in a CDS roll. So when the index has traded atsimilar levels as today,we would consider a normal roll to be somewhere between five and a half or sixbasis points. So that's what that longer maturity of the new index is typicallyworth. So, this one at seven and a half or eight is meaningfully wider than that,so we would consider that to be a steep roll.Now, this is in contrast to what we saw at the last roll in March.At that roll, we saw fair value at four and a half basis points, so actuallytighter or flatter than what we would typically see.And that was really driven by the names that were going into the index at thattime, trading tighter than the ones that were coming out.And so this time, we have the opposite.Now, for CDX IG in particular, investor positioning tends to be overwhelmingly longrisk. So what that means is that you have a lot more longs on the investor sidethan shorts, and it's that imbalance that tends to cause the roll to actually tradeflatter or tighter than fair value.And so that's really what we expect to see this time around.Now, the last roll, given that the fair value was fairly flat at four and a halfbasis points, we didn't really see that same effect kind of play out, rightRight... because there just wasn't as much of a spread pickup.Right.But this time we very much have the opposite, and we think that given this greaterspread pickup, that thelong investors will be incentivized to roll early, which could cause the roll totrade flatter than fair value.Okay. That's really useful info. And Nick, you used the wordexciting when you talked about the two new additions, at least from a hyperscalerperspective, being NVIDIA and SpaceX, right?Now, looking and sort of tapping into that AI theme and hyperscaler theme,going back to the March roll, how have we seensort of volumes, because at the March roll we had three new additions youmentioned. How have we seen volumes trend on both indices and single namessince the March roll?Yeah. So it is very exciting, and largely we can kind of distinguish between theactivity we're seeing in the hyperscaler and AI-related single names and everythingelse, other single names and indices overall.So there's still very healthy large activity in CDX andiTraxx overall. However, on the back of a more stable credit market in general,activity is marginally down, generally speaking.But when we look at the hyperscaler CDS across the board,the trading volumes tend to be multiples of what they were in the latestsix-month period versus the prior six-month period. And actually, if we look at whatis expected to be the new CDX investment-grade composition, the seven mosthighly traded names are all hyperscalers.And leading the list is Oracle, as it has been for the last number of rolls,followed by Amazon, Alphabet, Broadcom, Meta, Microsoft, andNvidia. And Nvidia is a really interesting one because in the six monthsfrom last September through this March, the entity traded around640 million in single name CDS. In the most recent six-month period, thatballooned to 6.9 billion. So we've seen more than a 10 X increase inactivity for that name. Similarly, if we look at Broadcom, Broadcom rose from about1.5 billion in trading from the initial six months in a12-month look back to 8.2 billion in the most recent period.And then if we look at other hyperscalers, they've tended to, in the most recentsix months, at least traded about three times more than they did prior.So we're seeing a real explosion in the use of trading thesehyperscaler names.No, that's great. Certainly good for the CDS, the health of the market to seecontinued activity in these story names, if I can call them that.But quickly pivoting to the high yield roll, which kind oflags the IG roll. We don't certainly have a preview at this stage, but perhaps itwould be really good to get your insights as to what you expect to happen, despitethere not being a preview at this stage.Yeah. So what I can say is fairly limited, but we can point to what we already knowabout CDX investment grade and the expectations that were published, specificallywith the three entities expected to leave high yield.That is Carnival, Vistra Operations,and Tele pharmaceutical Industries.But in general, I think something that we can say is that over the last severalroll periods, since there hasn't been as much liquidity in the high-yield singlenames to use to make selections, we've had to increasingly look at cash marketinformation, such as the size of the debt stack for high-yield issuers, coupledwith trace volumes to look at the general activity in those entities.And we've used that as a mechanism to add them to high yield.And when we've done that, we've generally seen either the creation or the pickup intrading in those high-yield single names, which has been a great effect.Great. Jacob, I'm going to pivot to you quickly.We don't have a preview list, but I'm sure you guys have a view.Once again, on the high yield, how do you expect the market to trade in terms ofspreads?Yes, as you said, we don't have a complete picture, but we did publish a high yieldroll preview a couple of weeks ago.And so based on our early estimates, we do think the high yield roll is likely totrade flatter or tighter than what we typically see.So very much different than what we're expecting on the IG side.But again, it's still a little too early to say.Yeah. And I must use the opportunity to also comment on your predictions because atleast on the IG, when we talked about it earlier, it was predicted a six, and youguys nailed it. So let's see how that plays out when it comes to the high yield aswell. But quickly pivot ontoiTraxx.Start with the Main. So what are your expectations,Nick?So the expectations for iTraxx Main are really DHL and Clarion to enter theindex, and Hochtief and Vinci to leave, reducing construction andinfrastructure exposure.Within TMT, Ericsson and RELX replace Telekom Austria andbroadening representation across technology information services. Yeah.Yeah. AndJigar, once again, you guys must have a view as to how you expect the Main to tradein terms of spread levels. Perhaps you just give us a bit of an insight as to howthat plays out given the four names sort of in and out switch.Sure. So based on our kind of sum of the parts or fair value estimate, we think thenew Main series will trade five and a half to six basis points wider than thecurrent one. So certainly somewhat flatter than what we're expecting on the IGside. Now, Main is also interesting in that it has a similar dynamic as IG in thatyou have more longs and shorts in the index.Yeah.And that typically can drive flattening pressure.It could cause the roll to trade flatter or tighter than what the fair value wouldtell you or would imply. But five and a half to six basis points is actually afairly typical roll. So we think that that flattening pressure is likely to be morelimited than what we're expecting on the IG side.And how do you expect the European roll dynamics to differ fromtheUSroll by way of relative value trading?Yeah. So great question. So one of the more common relative value pairs that we seetraded in the market is iTraxx Main versus CDX IG.They're both investment-grade indices.They are considered to be broad proxies for investment-grade risk in each region.And so investors will take a relative value view going long one, short the other.And so currently, in the current on-the-run series, Main trades two basispoints wider-Yeah... than CDX IG. Now, if our estimates are realised, then in the new series,they'll trade flat to each other. And so we think that investorswho are trading these pairs actively and are concerned about perhaps a furtherescalation in the Middle East, perhaps concerned about a further increase in oilprices,are more likely to buy protection in Main than IG.And if that basis is flat in the new series versus two basis points in the currentone, that could drive protection buying in the new Main series relative to the newIG series.Yeah. Thanks for that colour. And Nick, just before we move away fromthe iTraxx piece, anything to particularly tease out when it comes toCrossover?So I think in Crossover we're seeing a little more turnover than we are in iTraxxMain. We see Altice France re-entering Crossover following its debtrestructuring. Ericsson, Inwit, and Caxo exit, while BelronUK, Motionfinco, and Mellon Energy and Metals are expected to increaserepresentation across leveraged consumer, business services, and industrialsectors. And it's worth noting that Ericsson leaving the Crossover universe andentering Mainis a bit of a connective tissue to what we're seeing in CDX IG.That is upgrades from sub IG to IG, and those changes reflected inthe indices.And Jigar, finally, as we try and wrap up the conversationon options, what are your thoughts?Obviously, a lot more short-dated, but how do you expect behaviours to change ornot change approaching the roll in a few weeks?Yeah. So as you mentioned, options tend to be very short-datedfor both CDX IG Main Crossover. Because of their short-dated nature, we thinkinvestors are more likely to just stay in their positions.We don't really see a significant amount of rolling in options, unlike what we seein index. But what we think is going to happen is that when these new series startto trade, you will see a pickup in options activity as people look to add new risk.We do see investors who are hesitant to start new positions close to the roll,knowing that there'll be a new series starting to trade.So we would expect activity to really ramp up next week once the roll happens, andin the subsequent weeks after.No, great. So thank you for that insight.And Nick, thank you for your insights as well. I think that's a wrap.It's been a very good conversation, good insights into what to expect in the comingweeks as we approach the roll.For any of our viewers, if you have any specific clearing-relatedquestions, do feel free to reach out to the CDSClear team.And thank you both, gentlemen, for making time.I thought that was a really interesting conversation. Thank you.Thank you.
