SOVEREIGN RISK HASN´T GONE AWAY / THE WALL STREET JOURNAL

HEARD ON THE STREET

SEPTEMBER 30, 2009, 12:06 P.M. ET

Sovereign Risk Hasn't Gone Away

By RICHARD BARLEY

It's a sign of the times. The newest credit derivatives index in town covers 15 Western European sovereigns, including France, Germany and the U.K. The start of trading this week of the Markit iTraxx SovX Western Europe underlines that even as markets look ahead to a hoped-for recovery, sovereign risk for developed countries remains clearly on investors' radar.

Sovereign risk remains a live issue as government bond issuance hits stratospheric levels and debate continues over exit strategies from stimulus. That implies continued active trading in credit default swaps on developed countries, even if a default seems a remote risk. Indeed, the Western Europe index has moved to active trading ahead of a sister index that covers countries from central and eastern Europe, the Middle East and Africa that would more usually be regarded as risky.

The new SovX index can be used both as a hedging tool and to express views about sovereign risk versus other types of credit risk. For instance, an investor could sell protection on SovX and buy protection on the iTraxx Senior Financial index to express the view that once Western European banks can stand on their own feet, credit risk will be transferred back to the private sector, Barclays Capital suggests. Or investors who have strong views about the credit deterioration or improvement of a single sovereign but want to avoid exposure to overall market direction could hedge their single name position with the index.

Meanwhile, for those outside the market, the index price will be an indicator of systemic risk perception in the credit market. At Tuesday's level of around 47 basis points, the index remains close to double the theoretical price calculated a week after Lehman Brothers' default, in contrast to some other credit market indicators that have recovered to summer 2008 levels. A sobering thought.

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