What is the Loan Credit Default Swap Index?
The Loan Credit Default Swap Index – Markit LCDX is a specialized credit default swap (CDS) index covering only 100 individual North American companies with unsecured debt traded on the major secondary markets. The LCDX is traded over the counter and is managed by a consortium of large investment banks, which provide liquidity and assist in the pricing of individual credit default swaps. IHS Markit Ltd, headquartered in London, is the index provider.
Understanding the default credit swap index (Markit LCDX Works)
The index starts with a fixed coupon rate (225 basis points); trading moves the price and changes the yield, much like a standard bond. The index rolls every six months. Buyers of the index pay the coupon rate (and purchase the credit event protection), while the sellers receive the coupon and sell the protection. What is protected in this case is a “credit event” in a particular index business, such as default or bankruptcy.
If such a credit event occurs in one of the underlying companies, protection is paid by physical forgiveness of debt or through a cash settlement between the two parties. The underlying company is then removed from the index and a new one is replaced to return the index to 100 peer members.
Credit default swaps essentially put a price on the risk that a particular debt issuer may default. Companies with good credit ratings have low risk premiums, so protection can be purchased for a minimum commission, assessed as a percentage of the notional value (in dollars) of the underlying debt. Companies with low credit ratings are more expensive to protect, so credit default swaps covering them can cost several additional percentage points of the notional amount.
Minimum purchase amounts for the LCDX can reach millions of dollars, so most investors are large institutional firms, such as asset managers, banks, hedge funds, and insurance companies, who invest either as a hedge or as a speculative game. The advantage of the LCDX for these investors is that they can access a diverse group of companies for much less than it would cost them to purchase the credit default swaps individually.