Thomas Huertas, director of wholesale firms at the Financial Services Authority, has lashed out at the use of constant proportion debt obligations (CPDOs), a new breed of synthetic credit investments.Speaking at Standard and Poor’s (S&P) Global Banking Conference in London, Huertas said “Gibson Greeting Cards and Bankers Trust come to mind” when discussing CPDOs. His comments appear to refer to a lawsuit filed by Gibson Greetings in 1994 where it claimed that Bankers Trust, now a part of Deutsche Bank, misrepresented the risks associated with the derivatives instruments it sold to the company that subsequently caused it to suffer large losses.
The action by Gibson Greetings, along with other companies around that time, led to a chorus of calls for the regulation of the over-the-counter derivatives business.
The CPDO structure was developed by ABN Amro, which road-showed its ‘Surf’ product in July this year. CPDOs use dynamic leveraging adapted from constant proportion portfolio insurance techniques but maintain debt obligation characteristics, notably fixed-income bullet cashflows.
The Dutch dealer has worked with both S&P and Moody’s to obtain ratings for its CPDO structures. It’s first Surf deal achieved a AAA rating paying 200 basis points above Libor using a leverage of 15 times. The underlying credit portfolio is actively linked to the on-the-run investment grade iTraxx and DJ CDX indexes.
The transaction has been widely replicated by rival dealers. But a number of parties are concerned that investors do not understand the real risks associated with CPDO structures.
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