A top CDS trader quits the CDS market

By Felix Salmon
March 19, 2012

Ben Heller, a man who’s been trading CDS since before they were even called CDS, is out of the CDS market.

There have been rumblings about this market for a while: an FT article from March 9 quoted a series of unhappy people on both the buy side and the sell side.

One banker working on the Greek bond deal says: ā€œI almost wanted CDS not to be triggered just so it would kill off the instrument and then we could set about designing something better to replace it.ā€

But with Heller going on the record about this, the pressure on ISDA to fix what is widely seen as a broken system is surely going to increase. Because he’s not alone.

“Many of the people you know from EMCA,” he tells me at the end of this video, “are people who are very focused on this issue and who are not going to let this one go.”

The world has long forgotten EMCA, an attempt by investors in emerging-market debt to team up and provide a united front in the face of attempted sovereign debt restructurings. But back when it was founded in 2000, it included all the biggest names in the emerging-market debt world, including Heller, who was then at HBK; Mark Siegel, at MassMutual; Abby McKenna, at Morgan Stanley Asset Management; Mark Dow, at MFS; and Mohamed El-Erian, at Pimco. The membership of Dow and El-Erian was particularly important, because they had both worked for many years in the official sector (Dow at Treasury, El-Erian at the IMF), and were taken seriously by policymakers.

EMCA never really got off the ground as an organization, partly because it turned out that policymakers, and their advisers, were more likely to pay attention to individual members than they were to respond seriously to carefully-honed collective statements. But clearly these people retain a certain amount of power: you can see that in the way that Greece’s new 2042 bond got quietly split up into 20 different bonds, each maturing in a different year.

Why did that happen? Because to a certain extent, the market is valuing Greece’s debt by working out how much money Greece is realistically likely to pay its bondholders over time, and then divvying up that value among the bonds outstanding. If some of the bonds have earlier maturities and some have later maturities, then more of the value will end up in the early-maturing debt, and less of it at the end of the yield curve. And so the value of the new 2042 bond is going to be lower, this way, than it would have been if it was the only bond being issued.

Why would creditors want a bond to trade lower? Because this way the 2042 bond becomes the cheapest-to-deliver bond when the CDS auction is held today, and the lower the price of the cheapest-to-deliver bond, the bigger the payout for anybody holding credit protection, including basis traders like Heller.

It seems to me that there were two opposing constituencies in the Greek default. One group, led by European policymakers, were very happy to see the CDS market get broken — they hate CDS, in exactly the same way that CEOs hate short sellers. The other group, led by fixed-income investors, wanted to make sure that the CDS market operated relatively smoothly and that the payouts were fair.

In the end, it seems, the buy-side won — but with the vivid realization that they had gotten lucky. Fixed-income traders never want to rely on luck and fortune when it comes to things as important as default protection. And so Heller, for one, is out of the market completely — unless and until ISDA does a root-and-branch revamp of its documentation. Which, if it happens at all, isn’t going to happen any time soon.


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