Oil markets rattled as Credit Default Swaps signal banking concerns
Quantum Commodity Intelligence – Oil markets were rattled again Friday amid further turmoil from the banking sector, this time with the Credit Default Swaps market signalling contagion fears.
A spike in the CDS of Deutsche Bank from around 140 basis points to over 170 bp late Thursday shook markets, flagging concerns of further European banking contagion after the collapse of Credit Suisse and subsequent takeover by UBS in a Swiss government-backed deal.
Deutsche Bank's US-listed shares tumbled over 10% Friday, sending shivers across the European banking sector, in turn spilling over into oil markets.
Credit Default Swaps act as an insurance policy against default - a hot-button topic with Credit Suisse bond holders set for a legal battle with the Swiss government.
They were first marketed by JP Morgan in the mid-1990s but only came on the radar of oil traders during the credit crunch of 2007-2008 and broader banking crisis.
At the height of the credit crunch in the summer of 2008, bank CDS levels became a must-have in assessing counterparty risk, while several commodity trading houses also saw sharp spikes in CDS rates, albeit on relatively low volumes and huge volatility.
Prior to that credit crunch, few energy traders had even heard of Markit, which is primary supplier of Credit Default Swaps information and sometimes referred to as the 'Platts of the CDS market'.
Markit
Back then, Markit was an independent company but was acquired by IHS in 2016, which since the 2022 merger with S&P Global is now part of the same stable as Platts.
The collapse of Lehman was particularly controversial among energy traders, with many instructed by credit departments to continue transacting with Lehman even after the bank's CDS were skyrocketing in the run-up to bankruptcy.
When Lehman collapsed, leaving a trail of open positions, individual or desk books at some trading houses were forced to wear bad counterparty positions on P&L, despite being instructed to continue trading with the beleaguered bank.
Traders at Oil majors were more fortunate, with the wider trading division taking over bad counterparty positions.
Prior to market reforms, individual traders would know the buyer or seller via brokered over-the-counter markets, and could instruct a broker not to match with a certain counterparty.
Since the futurization of OTC markets, counterparties are anonymous, erasing the direct risk from a default, but CDS will send a strong signal on the overall health of the financial sector.
