Asia Sovereign Risk Index Starts as Government Debt Focus Grows

May 3 (Bloomberg) -- Asia’s newest bond risk benchmark and only purely sovereign index begins trading tomorrow as European credit downgrades sharpen investor focus on government debt.

The Markit iTraxx SovX Asia Pacific index will track credit-default swaps on debt of China, Malaysia, Thailand, South Korea, Vietnam, the Philippines, Indonesia, Japan, Australia and New Zealand. Each nation will be equally weighted and the index will be traded in U.S. dollars with a five-year maturity.

“This is a welcome addition,” Joseph Yiu, a credit trader at Westpac Banking Corp., said in a phone interview from Sydney. “It will allow investors to play the sovereign index off against single names, which should increase liquidity.”

Standard & Poor’s last week downgraded Greece, Portugal and Spain, prompting Angel Gurria, head of the Organization for Economic Cooperation and Development, to warn of the risks caused by the build-up in sovereign debt.

The sovereign credit swap index attracting most interest from traders is the Markit iTraxx SovX Western Europe, Yiu said. It rose 36.5 basis points last month as European Union and International Monetary Fund officials put final touches on a package that will let Greece tap emergency loans.

Markit Group Ltd. London-based spokeswoman Caroline Lumley confirmed the May 4 start date and declined to comment further.

Starting Level

Credit-default swaps are used to speculate on the creditworthiness of a company or government, or to hedge against losses on bonds and loans, and let buyers demand payment from sellers if the underlying borrower fails to make scheduled interest or principal payments. Prices rise as perceptions of creditworthiness deteriorate.

Based on an average of the 10 countries to be included, the SovX Asia Pacific index should start trading around the 105 basis-point mark, and track the SovX Western Europe index, Barclays Capital credit analysts led by Soren Willemann said.

“We’ve been trading SovX Western Europe since September and it’s been a good product launch with a variety of accounts involved,” Willemann said by phone from London. On a theoretical historic basis, the two indexes would have “exhibited a very strong relationship,” he said.

The wide range of nations in the SovX Asia Pacific index may make it difficult to reflect sovereign risk, according to Brayan Lai, a credit analyst at Credit Agricole CIB.

“If you’re looking at a systemic hedge against Asia it might be reasonably useful, but the countries included differ so much in so many respects,” Lai said. Weighting countries according to the size of their GDP would be “more reflective of risk” as would splitting the index into developed and developing economies, he said.

‘Manipulate Markets’

China, the world’s fastest-growing major economy, has a gross domestic product almost 17 times the size of Thailand’s which in turn has an economy three times the size of Vietnam’s, according to data compiled by Bloomberg.

A sovereign swaps index in Asia may also give investors “more incentive to manipulate markets,” said James Dondero, Highland Capital Management LP president and co-founder. Greek Prime Minister George Papandreou blamed credit swap traders for worsening his nation’s debt crisis and driving up borrowing costs. “This index will make it easier for investors to bet on Asian sovereigns and distort things,” Dondero said in an interview in Singapore April 29.

Claims that default swaps are responsible for a surge in government borrowing costs are “flawed and inconsistent,” trade group the International Swaps and Derivatives Association said on March 15.