Fitch outlined its concerns in a report co-authored by analysts Roger Merritt, Ian Linnell and Robert Grossman, released today. According to Merritt, the rating agency’s primary concern is that CLNs and similar structured notes are correlated 100% to the credit profile of the company. "Liquidity and capital resources may be materially tied to a financial asset that has diminishing value at exactly the wrong time, when the company is under financial stress," said New York-based Merritt.
Companies enter into self-referenced credit derivative transactions for a variety of reasons, including regulatory arbitrage. Self-referenced CLNs typically offer higher returns than similarly rated securities, particularly if a company is thinly traded in the single-name CDS market and demand for protection buying exceeds demand for protection selling.
According to Fitch, investment in a self-referenced CLN has the potential to accelerate a company’s financial decline. Credit derivatives dealers Risk spoke to said this type of transaction has become increasingly common over the past two years. CLNs recently hit the headlines when it emerged that bankrupt Italian dairy company Parmalat had bought self-referenced notes with a notional value of tens of millions of pounds sterling.
The week on Risk.net,October 14-20, 2016Receive this by email