The International Index Company last week officially launched the iBoxx ABS-50 index that will provide a benchmark for European triple-A rated paper and also hedge future spread direction.
It's the first instrument that provides this hedging function to European trades.
"The future contracts will help take some position in a liquid fashion with longer shorts that will ultimately open the door for new participants," said Julien Mareschal, a trader at BNP Paribas.
The index was designed by IIC in conjunction with BNP Paribas, ABN AMRO, Deutsche Bank, Dresdner Kleinwort Wasserstein, JP Morgan and Morgan Stanley.
Several financial institutions contribute to the dealer poll and provide prices for the index constituents daily via Market Group's ABS pricing service. They include Bank of America, Barclays Capital, Calyon, Citigroup, Credit Suisse, DZ Bank, HSBC, HVB, IXIS, Lehman Brothers, Merrill Lynch, Royal Bank of Scotland, Societe Generale and UBS.
The index contains the 50 largest and most liquid European AAA-rated floating rate ABS and MBS securities and is rebalanced quarterly to keep track of new issuance. Index constituents are equally weighted. For the first time, players will be able to quantify relative value in the ABS market.
"The ABS market relative value will find some real meaning under the index," Mareschal said. " You are going to be able to develop some long/short strategy based on the way the market is trading."
Having so many banks participating at the launch of the product adds to the credibility of the index and opens the door for derivatives trading going forward.
"The index launch is the result of increased growth in the ABS/MBS market in Europe and rising interest from investors in having independent, market-standard indices," IIC chief executive David Mark said.
Quarterly rebalance
The index is rebalanced quarterly to capture the largest, most liquid issues. Only triple-A rated, floating rate ABS, MBS and SME CLOs issued during the last 12 months are eligible. Bonds must have a remaining weighted average life of at least 18 months. IIC selects the 70 largest eligible issues, from which the 50 most liquid are selected for the index via a dealer poll.
"The iBoxx index will improve the ability to benchmark for triple-A investors and allow trading of three-month futures to take spread direction bets or hedge positions," said Chris Greener, a researcher at the Royal Bank of Scotland. "We expect more products will be forthcoming should interest in the ABS-50 prove sufficient."
He added that the first deals are likely to be between trading desks hedging long bond positions, with some participation from hedge funds. Issuers are unlikely to use it as a tool to hedge future deals in the near term unless spread volatility increases.
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