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ISDA Risk and ETF Sell Off


Lisa Pollack, Alphaville, Introducing “ISDA risk” – it’s like basis risk, but more annoying, here. It’s going to take some work to get comfortable e-Trading SOV CDS in any kind of size. Stick with analysis of domestic corp CDS for now. It’s nice that Pollack is publishing prose again.

The longer term move is the logical consequence of doubt being cast on the ability of financial CDS to trigger and payout in a economic way — by which we mean in a way that reflects what actually happened to creditors of the equivalent cash instruments — particularly when it comes to subordinated CDS on banks.

The most significant seed of doubt was planted when the Dutch government nationalised SNS Bank. The subordinated debt holders saw their investment go to zero, but the CDS only paid out 14.5 per cent of notional to protection holders. Not what a CDS buyer would have hoped for.

Izabella Kaminska, Alphaville, ETF providers take the sell-off heat, here.

But we’re seeing now are ETF outflows and market sell-offs taking place simultaneously. This — relatively speaking — is something of a new trend for the industry. And it may (or may not) be linked to ETFs’ general over-reliance on arbitrageurs bridging the gaps.

We’d very speculatively suggest this could be the result of one of two things:

1) ETFs (not the market) are leading the sell-off and falling faster than the market, which is incentivising market arbitrageurs to buy cheap ETF stock, redeem it for underlying, and liquidate it into the market for a higher price. But it’s the ETF outflow which is now moving the market, not the market which is moving the ETF.

2) The market is still leading the sell-off, but market arbitrageurs for some reason are not prepared to buy cheap stock and create new ETF shares for a premium.

Point two seems somewhat illogical, which possibly suggests some ETFs may have become bigger than the markets they track.


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