What Is the Loan Credit Default Swap Index (Markit LCDX)?
Let me explain what the Loan Credit Default Swap Index, or Markit LCDX, really is. It's a specialized index made up of loan-only credit default swaps, or CDS, that cover 100 North American companies. These companies have unsecured debt that's actively traded in broad secondary markets. You trade the LCDX over-the-counter, and it's handled by several large investment banks—they manage it, provide the liquidity you need, and help with pricing those individual credit default swaps. The index provider is IHS Markit Ltd, based in London.
Key Takeaways
- The Loan Credit Default Swap Index (Markit LCDX) is a specialized index of loan-only credit default swaps (CDS) that cover 100 individual North American companies with unsecured debt trading in the broad secondary markets.
- LCDX is traded over the counter and is managed by a consortium of large investment banks, which provide liquidity and assist in pricing the individual credit default swaps.
- IHS Markit Ltd, headquartered in London, provides the index.
- The LCDX begins with a fixed coupon rate (225 basis points); trading moves the price and changes the yield, much like a standard bond.
- Minimum purchase amounts for the LCDX can run into millions of dollars, so most investors are large institutional firms, such as asset managers, banks, hedge funds, and insurance companies.
Understanding the Loan Credit Default Swap Index (Markit LCDX)
Here's how the LCDX works in more detail. The index starts with a fixed coupon rate of 225 basis points. When you trade it, that moves the price and adjusts the yield, just like you'd see with a standard bond. It rolls over every six months, so it stays current. If you're a buyer of the index, you pay that coupon rate and get protection against credit events. Sellers receive the coupon and provide that protection. What we're talking about here is protection from a 'credit event' at one of the companies in the index—things like defaulting on a loan or filing for bankruptcy.
If a credit event happens at one of those underlying companies, the protection gets paid out. That could be through physical delivery of the debt or a cash settlement between the parties involved. Once that's done, we remove that company from the index and swap in a new one to keep it at exactly 100 members.
Credit default swaps are basically a way to price the risk of a debt issuer defaulting. Companies with strong credit ratings have low risk premiums, so you can buy protection for a small fee—it's a percentage of the notional value of the debt. But if a company has a low credit rating, it costs more to protect against, sometimes several extra percentage points on that notional amount.
The minimum amounts to buy into the LCDX are in the millions of dollars, which is why you'll mostly see large institutional firms involved—think asset managers, banks, hedge funds, and insurance companies. They use it either as a hedge or for speculation. The big advantage for them is getting access to a diversified group of companies through this index for a lot less than buying each credit default swap on its own would cost.
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