Credit default swaps on Credit Suisse rallied sharply on Tuesday following a second industry ruling that the contracts had not been triggered, delivering gains to traders betting that spreads would converge with UBS ahead of the planned merger between the two former rivals.
Five-year CDS on Credit Suisse fell to 127bp on Tuesday, according to S&P Global Market Intelligence, down from 161bp at the end of last week. The gap to CDS on UBS, meanwhile, roughly halved to 34bp – the slimmest difference in at least a year. That gap had ballooned to more than 1,000bp in mid-March before Swiss authorities brokered UBS’s emergency rescue of its ailing rival.
The market moves will cheer funds betting on a convergence in CDS spreads between the two Swiss lenders. If the merger completes as planned, the CDS committee will probably be asked to rule on whether a succession event has occurred, when CDS contracts referencing one entity are transferred to another.
Monday’s confirmation that CDS on Credit Suisse had not been triggered looks to have provided the fuel for the rapid narrowing in spreads between the two lenders. That was the second time in under a week that the Credit Derivatives Determinations Committee, a group of banks and investment funds that rules on CDS market matters, voted unanimously against a credit event on Credit Suisse around the time of UBS’s takeover announcement.
The committee ruled last week that a government intervention credit event had not occurred following the wipeout of SFr16bn (US$17.8bn) in Credit Suisse’s Additional Tier 1 debt during its rescue. That came after hedge funds, including Diameter Capital and FourSixThree Capital, had loaded up on CDS that would pay out if the contracts were triggered.
The committee then had to rule on a separate bankruptcy credit event on Monday – a question experts had considered even less likely to trigger derivatives contracts. Still, the dramatic fall in Credit Suisse’s CDS spreads on Tuesday suggests lingering concerns over a potential trigger may have kept the cost of default protection on Credit Suisse at elevated levels in recent weeks.