MUMBAI: Even before ICICI Bank announced its mark-to-market loss on credit derivatives exposure, overseas money markets have been quietly pricing in the possible hit. Over the past one week the credit-default swap (CDS) premium — a protection price against default risk — on fixed securities floated by ICICI Bank has gone up 5%. Since early January, the CDS premium has gone up by 127%. Clearly, the credit crisis has worsened in the international market, pushing up the protection price.
On Tuesday, ICICI announced a mark-to-market loss of $263 million on account of exposure to credit derivatives in the overseas market. ICICI’s total exposure to credit derivatives is $1.5 billion. Technically, a rise in the CDS price hints at higher default risk. However, this is purely a function of the market and decline in liquidity, and is not a reflection on the credit worthiness of the issuer.
CDS, which works like an insurance, is bought by investors to protect themselves from likely defaults from companies which issue debt instruments. Just like other bonds and stocks, they are quoted in the market.
In the first week of January, these instruments (CDS on ICICI papers) were traded at $141. Interestingly, as the CDS prices rose, it had an impact on the stock market price of ICICI in the local market. As if, the equity price was taking cues from the CDS quotes.
ICICI Bank saw a 52-week high on
Internationally, the overall derivative market stands at $ 415 trillion with credit derivatives at around $41 trillion, growing at more than 25%. The squeeze in the financial markets has suddenly brought out the embedded risks in these products.
“CDS instruments are magnifying the problem. But one can only say that these instruments are transparent and if there is going to be trouble from this side of the market, in a way it can be quantifiable,” says ING Investment Management, head of fixed income, Asia Pacific, Timothy Matson.
Understandably, the CDS risks are captured in the mark-to-market hits taken by financial institutions even if they have no exposure to subprime mortgages. With the market turning volatile, local traders are beginning to track the CDS quotes to fish for more clues on the scrip.
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