Merrill touts restructuring strategy

Merrill proposed investors move towards long protection strategies on credit derivatives where restructuring language is present related to the underlying. Its report said that the Bank for International Settlements (BIS) is moving towards allowing capital relief on non-restructuring credit default swap positions. These derivatives are commonly used as hedges on obligations where the investing bank has the right to veto restructuring decisions.

Merrill believes that if the BIS continues on its present course, significant impact on the market may result: first, long-term growth is likely as a result of new protection sellers being drawn into the market. Second, globalisation is likely as European and US contracts converge. Third, the market will expand for obligations that give the holder the right of veto over prospective restructuring, and finally, the balance of the conflict of interest of banks hedging with credit default swaps is likely to be altered.

Merrill said there is a likelihood that buyer-friendly restructuring events may effectively disappear, hence its recommendation to buy restructuring now. Alternatively, it suggests that investors might benefit from present circumstances by taking short positions in the credit default swap market or by buying negative basis bonds against default combinations.