A new short-selling tool in the private credit market: Wall Street giants launch CDS targeting Blackstone and Apollo

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Wall Street is building new short-selling mechanisms for the $2 trillion private credit market.

According to the Financial Times, citing sources, JP Morgan, Barclays, Morgan Stanley, and Citigroup have recently started trading credit default swap (CDS) contracts based on flagship private credit funds under Blackstone, Apollo Global Management, and Ares Management. This is the latest development in Wall Street’s ongoing exploration of short-selling tools for private credit, providing investors with new methods to bet on or hedge risks in this sector.

This move comes at a sensitive time for the private credit industry, which is under pressure. Several private credit funds are facing a wave of investor redemptions, their own financing costs are rising as banks tighten lending terms, and regulators are increasingly concerned about the deep intertwined relationships between banks and private credit funds. Notably, since these CDS contracts began trading this week, the CDS spreads for all three funds have narrowed, and JP Morgan strategists expect the CDS spread for Blackstone’s flagship private credit fund (BCRED) to further compress.

The launch of the new tool has triggered a renewed examination of risk pricing mechanisms in the private credit industry and reflects institutional investors’ growing caution toward this rapidly expanding but relatively opaque asset class.

S&P Index Launch Triggers CDS Market Activation

The launch of the above CDS contracts was directly catalyzed by S&P Global’s release of a new index this week. S&P recently introduced an index called "CDX Financials," which includes funds managed by Apollo, Blackstone, and Ares, as well as banks, insurance companies, real estate firms, and other financial groups.

Within days of the index launch, major banks began actively trading CDS contracts for the index’s constituent funds. These contracts allow traders to bet on whether individual funds will default on their borrowings. Among them, Blackstone Private Credit Fund (BCRED) is the largest, with $83 billion in assets under management.

Nicholas Godec, S&P Global's Head of Tradable Fixed Income Products and Commodities, said there has been a clear increase in demand from traders and investors for managing private credit exposure in recent months. "Whenever there are market concerns about risk, CDS activity heats up," he said:

"It is precisely this feedback loop from the market that led to the creation of this index."

Multiple Uses: Shorting, Hedging, and Arbitrage

The newly launched CDS contracts have multiple functions and are not solely for short-selling purposes.

Investors can use CDS to bet that overall sentiment in the private credit industry will deteriorate, even if they do not believe the relevant funds will actually default—for as perceived risk in the funds rises, CDS prices will follow. Meanwhile, many traders are using the spread between CDS contracts and fund bonds for arbitrage, betting on either widening or narrowing differentials to profit.

Additionally, media reports citing sources indicate that some credit investors are directly shorting investment-grade bonds issued by private credit Business Development Companies (BDCs), while others believe these bonds have been oversold and are considering buying at lows.

Previous Wall Street Attempts Stalled, CDS Model Leads Breakthrough

This CDS product launch marks the first substantial progress among multiple attempts on Wall Street.

Goldman Sachs and JP Morgan previously explored using total return swaps (TRS) as derivative tools to bet on loans made by private credit institutions to private equity-backed software companies, but so far there seems to be no sizable or substantial trading. Bank of America also advised clients to bet on stocks its sales team considered "most vulnerable to private credit," but eventually withdrew the recommendation.

The logic behind some investors betting on shorting private credit is: The industry extends substantial loans to software firms backed by private equity, and the rapid advent of artificial intelligence may disrupt these companies’ business models, potentially leading to higher default rates.

The launch of the new CDS contracts comes as the private credit industry faces several headwinds. In addition to continued investment redemption requests, fund financing costs are rising due to banks tightening lending conditions. At the same time, regulators are increasing their focus on the deep entanglement between the banking system and private credit funds.

Nevertheless, trading activity in the current CDS contracts remains relatively limited. Participating banks such as JP Morgan and Barclays have declined to comment.

Risk Warning and DisclaimerThe market carries risks, and investment requires caution. This article does not constitute personal investment advice, nor does it take into account individual users’ specific investment goals, financial situations, or needs. Users should consider whether the opinions, viewpoints, or conclusions in this article are suitable for their particular situations. Investing accordingly is at your own risk. ```