A large global sell-off last week was likely sparked by a single trade in Deutsche Bank's credit-default swaps

Deutsche Bank
A man walks past Deutsche Bank offices in London December 5, 2013. Luke MacGregor/Reuters
  • A single $5 million trade in credit-default swaps for Deutsche Bank likely sparked last week's stock market decline, Bloomberg reported.

  • Credit-default swaps are an extreme form of insurance against the potential default of a company.

  • The trading instruments are incredibly illiquid, which means one small trade can lead to an outsized move.

Last week's sharp decline in Deutsche Bank stock, which helped spark a broad sell-off in global equity markets, could have been caused by a single trade in the bank's credit-default swaps.

Regulators are investigating a $5.4 million trade on credit-default swaps tied to the bank's junior debt, according to a Bloomberg report.

Deutsche Bank's credit-default swaps nearly tripled on Friday, leading to a near-10% sell-off in the stock and a $33 billion decline in market value for an index that tracks European banks.

The volatile move sparked fresh fears among investors that the banking crisis that started with Silicon Valley Bank earlier this month and spread to Credit Suisse shortly thereafter was about to hit one of Europe's largest banks.

Credit-default swaps are a form of insurance against missed payments on debt. The trading instrument was successfully used by some investors who bet against the housing market in 2008, including Michael Burry of Scion Capital. Protection payouts on the credit-default swaps are triggered when a debt payment is missed.

The relatively small trade that could have sparked the big sell-off on Friday highlights the illiquidity of credit-default swaps markets. In other words, one small trade can lead to an outsized move.

And with nervous investors looking for any sign to flee after the biggest bank collapse since 2008, it makes sense that such a spike in insurance against a major bank's default could have triggered a global sell-off.

The recent move in credit-default swaps tied to various banks also highlights the lack of transparency in the asset class, European Central Bank's top oversight official Andrea Enria said at a conference on Tuesday.

"There are markets like the single name CDS market which are very opaque, very shallow, very illiquid. With a few millions, you can move the CDS spreads and contaminate also stock prices and possibly also deposit outflows," Enria said.

It is not known who made the credit-default swap trade or the reasoning behind the trade. One person familiar with the matter said the trade could have been a simple hedging trade, which makes sense given the ongoing fears in the banking market and the long-running issues at Deutsche Bank.

Read the original article on Business Insider