Investors in European bonds now have a new tool at their disposal. With the iBoxx family of bond indices, the bond market finally has access to a reliable and transparent benchmark, claims the newly formed company behind the index.
“It’s something that’s completely different in the grey world of fixed income indices,” says David Mark, chief executive of the new venture, iBoxx Ltd. Mark – previously with the WM Company in Frankfurt – took the new post in mid October.
The indices, says Mark, herald the beginning of a new era of rules-based, replicable and continuously priced benchmarks for the fixed income market.
iBoxx is a joint venture between ABN Amro, Barclays Capital, BNP Paribas, Deutsche Bank, Dresdner Kleinwort Wasserstein, Morgan Stanley, UBS Warburg and Deutsche Börse.
“We’ve carefully selected the banks in the consortium in accordance with their consistent ability to generate and technically deliver high quality prices for Euro-zone and Sterling bonds. Deutsche Börse is the independent third party which controls the quality of incoming prices and calculates the indices,” says Mark.
The fixed income market suffers from a notorious lack of transparency for bond market investors. Relevant information and ‘good’ bond price data are often carefully protected by the trading houses, says Mark.
“iBoxx is trying to make markets more transparent,” he says. “Drawing on the experience of Deutsche Börse in organising fragmented and unstructured markets has been a benefit in defining the orientation of iBoxx.”
Unlike equities, bonds are generally not exchange-traded and this means there is no single ‘valid’ price available. The bid and ask quotes for bonds depend on the positions of the respective trading house you are dealing with.
“Fixed income indices have lots of catching up to do when compared to equity indices,” says Mark. The lack of transparency seriously hampers the efficiency of the bond markets and therefore there are virtually no exchange-traded derivatives on non-government bonds available.
“As a fund manager, if you want to hedge the bond indices that you’re benchmarking your portfolio against, you’re pretty much restricted to going to one of the proprietary index providers,” he says. But the snag is then if you want to sell that instrument, you must go back to the place you bought it, and accept whatever price you’re offered, he says.
When derivatives based on the iBoxx indices are launched, he says, market participants will be able to go to any of the iBoxx banks and trade the instrument. In this way, the iBoxx partners are creating instruments which are somewhere in between the OTC market and exchange-traded derivatives. Mark says it could be described as an “organised OTC market”. “Further down the road you may have proper exchange-traded derivatives,” he says.
iBoxx currently publishes the iBoxx Euro family as well as Sterling Gilt indices. Sterling Corporates and others will be launched in the near future. The indices are grouped into four distinct sub-index families.
These are sovereign and sub-sovereign, which replicate the market for bonds issued by national governments or regional governments, government-like institutions and organisations. There is a separate sub-group of indices for bonds secured by collateral and the fourth index sub-group is composed of corporate bonds.
The indices have been designed to be used for a wide variety of investment strategies, iBoxx says. Each index family includes aggregate indices summarising large sections of the market, detailed sub-indices for specific market segments, rating indices, maturity indices and index analytical values.
The banks in the iBoxx consortium supply prices for the securities comprising the iBoxx indices throughout the trading day. Both bid and ask quotes are delivered via dedicated lines directly from the trading desks of iBoxx banks to Deutsche Börse.
Here the prices are quality controlled using a variety of criteria and then consolidated. Once each bond has an “official” iBoxx price the indices are calculated. Both prices and indices are then disseminated via information vendors. “We’re trying to take away the subjectivity in prices,” says Mark. “The whole index model is completely transparent – anyone can see the rules,” he says.
All index-related activities such as bond selection, price consolidation or the monthly re-balancing are based on a set of rules which are freely available to the public. Oversight committees composed of experts from buy-side organisations, market regulators and consultants make sure the rules are strictly adhered to.
The shareholders in iBoxx are not members of these oversight committees, ensuring their independence, says Mark.
There is already good market demand for the iBoxx real-time bond prices and
for derivatives licences on the iBoxx indices, he says. “Fund managers and custodians want to use iBoxx prices for portfolio valuations,” he says.
iBoxx expects to licence the indices as benchmarks for passive funds, and in the future there could be exchange-traded funds based on the indices too.
The new family of indices has been launched at a time when bonds are in increasing demand. With the weakness in the equities markets showing no signs of abating, institutional investors are seeking the relative shelter of fixed income.