Greece: crashing out of another index

March 15, 2012

Never mind that Fitch  upgraded Greece’s rating to B minus this week from restricted default after the country completed its bond exchange — for the credit default swap market, the exchange is still classed as a default. And for Greece, that meant ejection this week from the closely-tracked Markit iTraxx SovX Western Europe CDS index.

Poor Greece has been trading in somewhat of a market hinterland since problems with its debt first led to ratings downgrades in mid-2010. It got ejected first from the Barclays and Citi developed world bond indices and last year its corporate bonds were thrown out of BoAMerrill Lynch’s bond indices.

Fund managers often base their investments against these  indices, and are loath to take heavy bets by leaving out any one constituent altogether. But as soon as a constituent is removed, all bets are off.

The problem is particularly acute as most emerging market indices don’t want to take Greece on either. For equity indices, the market is too developed, while for sovereign bonds, it doesn’t have a liquid enough supply of dollar debt.

Meanwhile, the removal of Greece from the SovX index has led to a sharp tightening. The index is trading at 226 basis points today, down from the last close in which it contained Greece, at 353 bps.

Next focus is  Greece’s credit auction on Monday, but this is not expected to cause a Lehman-style market shock, as the amount of CDS outstanding, at around $3 billion,  is manageable.

According to Barclays analysts:

In a situation such as this one, where the default has been well telegraphed and priced by the market…risks are significantly ameliorated. The net notional exposure is relatively small from a systemic perspective, and the vast majority will have already been marked to market. Thus any incremental losses should be manageable for large market participants.



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