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The usage of any
instrument is directly correlated with the familiarity of
the instrument. One cannot claim oneself to be an expert
in any financial instrument only by reading, writing and
monitoring the market movements. Any financial instrument
has to pass the test of time. Credit derivative products
and Collateralized Debt Obligations (CDOs) are really experiencing
the test of time. The volatility in the credit risk market
in the past resulted in defaults of Enron, WorldCom, and
Marconi, and today the subprime issue has forced credit
investors to pay firm attention to product designing and
valuation thereof.
The
history of CDOs can be traced back to the 1980s, but the
introduction of David's Gaussian Culpa models in 2001 gave
a boost to the credit derivative market and credit pricing
in particular.
Synthetic
CDOs are highly useful for credit risk transfer. This is
because without really selling the asset one can transfer
the credit risk, and this may be the reason why synthetic
CDOs have gained so much recognition. Complexity in valuing
synthetic CDO and the failure of the recovery model adopted
can be considered as the causes which led to the turmoil
in the US economy and which had far-reaching impact on imports
in the emerging markets.
Emerging
Market Credit Derivatives (EMCD) are increasingly becoming
popular despite initial hindrances like lack of liquidity,
legal and disclosure issues. The Credit Default Swaps (CDS)
are most accepted among the asset managers, banks and investors
in spite of the current happenings in the US market. It
is considered to be a favorite instrument for bank's balance
sheet management.
Securities
Industry and Financial Markets Association (SIFMA) is an
industry trade group which was formed after merging the
Bond Market Association and the Securities Industry Association
on November, 2006. It has come out with quite transparent
and prudent guidelines for credit derivative and CDO markets.
As
a matter of fact there are five major international trade
associations namely, International Swaps and Derivatives
Association (ISDA), European Securitisation Forum (ESF),
International Capital Market Association (ICMA), London
Investment Banking Association (LIBA) and Securities Industry
and Financial Markets Association (SIFMA). It is difficult
to exactly state which one to abide by. To solve this problem
ISDA has come out with a press release on principles for
managing the provider-distributor relationship stating the
following: "The principles are drafted with no single
jurisdiction in mind; they are, on the contrary, intended
for global use, at a high level. Regulatory treatment may
depend on the nature of the component instruments; for instance,
depending on the jurisdiction, structured deposits or exchange-traded
notes acquired by investors via brokers on a `reverse-enquiry'
basis may each require separate analysis."
A
tense credit market will make this year quite an exigent
year; it is expected that emerging markets like India and
China will have a stable growth and global market will see
a lot of consolidations.
-
Sharon K Jose
Consulting
Editor
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