Fitch Ratings said it expects to make “appropriate adjustments to liquidity and capital measures” for any company that purchases a self-referenced credit derivative.Self-referenced credit-linked notes (CLN) involve a company selling protection on itself by purchasing a security that includes an embedded credit default swap (CDS), with the company as the protection seller and the reference entity.
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.
More on Structured Products
UBS suffers VAR exception on huge P&L swings following scheme’s launch
Dealers tout hybrid credit and equity-linked notes with Eurostoxx 50 exposure
Risk comparisons must be made easier under Priips KID, says AMF
JAC calls on regulators to co-ordinate cost disclosure rules in KID with Mifid II
Sign up for Risk.net email alerts
Sponsored video: MarketAxess
Sponsored video: Tradeweb
Multifonds talks to Custody Risk on being nominated for the Post-Trade Technology Vendor of the Year at the Custody Risk Awards 2014
Sponsored webinar: IBM Risk Analytics
There are no comments submitted yet. Do you have an interesting opinion? Then be the first to post a comment.