Maybe the consolidation trend affecting stock exchanges is providing some inspiration among electronic marketplaces for over-the-counter financial products. On Tuesday, credit-derivativesinter-dealer brokersCreditex and CreditTrade announced that they will merge to form Creditex Group.
Creditex and CreditTrade both act as intermediaries between credit-derivatives dealers. There are also a number of electronic platforms that facilitate dealer-to-end user trading, including Thomson's (NYSE:TOC) TradeWeb and bond ECN MarketAxess (NASDAQ:MKTX). These compete with single-dealer proprietary platforms run by BNP Paribas and Barclays Capital, a unit of Barclays (NYSE:BCS).
Credit derivatives might seem to be an obscure part of the financial markets, but the category has more than doubled in size in each of the past two years, to reach $17 trillion in outstanding notional value in 2005. Although the mechanics of some of these products are complex, they are essentially a form of insurance for bondholders.
Let's imagine you're a fund manager who owns the bonds of fictional auto-parts supplier Steering Wheels Inc., and you wish to protect yourself against the risk that the company will go bankrupt in the next five years. To do that, you could enter into a credit default swap (one type of credit derivative) with JPMorgan Chase (NYSE:JPM). As the protection buyer, you would pay an annual premium to the bank (the "protection seller"), and in return, the bank agrees to make a lump-sum payment to you in the event of bankruptcy during the five-year life, or "tenor," of the swap.
The Creditex/Credit Trade merger is a sign that the credit-derivatives industry is maturing. The new Creditex Group could in turn be an attractive acquisition target for a company such as marketplace-technology provider and former Motley Fool Hidden Gems pick eSpeed (NASDAQ:ESPD). Another potential suitor could be Chicago Mercantile Exchange Holdings (NYSE:CME), which is extending its reach beyond traditional exchange-traded products. On July 5, the CME announced its acquisition of Swapstream, an electronic trading platform for euro- and Swiss franc-denominated interest-rate swaps.
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JPMorgan Chase is an Income Investor recommendation.
Fool contributor Alex Dumortier has no beneficial interest in any of the companies mentioned in this article. He welcomes your (constructive) feedback. The Motley Fool has a strict disclosure policy.
