Fitch releases CCO criteria, gives views on CFXOs ..

Rating agency comments on new credit structures

Fitch Ratings is prepared for further collateralised commodity obligation (CCO) issues - following the inaugural issue of $190 million in CCO notes by Credit Suisse - with the April publication of its rating criteria for CCOs. Last month the agency also published its considerations for analysing and rating collateralised foreign exchange obligations (CFXOs).

Derivative Fitch, the rating agency's derivatives analysis and rating arm, says the new CCO criteria "will increase transparency in the market and the understanding of CCO ratings".

As part of the release, Fitch launched a public Vector CCO model - the main analytical tool for the quantitative analysis of the reference portfolio - to replace the beta model released in January.

Some market participants are positive about the new model. "Fitch's ratings model for these underlyings makes a lot of sense, and provides fair and meaningful ratings," says Gunnar Hoest, a director of fixed income at Credit Suisse in Hong Kong and part of the team that developed the inaugural long/short CCO issued in April.

"We have also been in discussion with other agencies and they also already have - or are working on further developing - rating criteria for commodity products," he adds.

The criteria and the model allow market participants to closely replicate Fitch's analysis for CCO transactions, says the agency. The document also covers Fitch's analysis of the other risks in a CCO, including structural risks, charged-asset risk and counterparty risks, as well as different types of CCO, such as managed CCOs and hybrid CDOs of commodity and credit risk.

"We designed the model to replicate five key risks that we saw in historical data," says Lars Jebjerg, senior director at Derivative Fitch in London. "These are a high frequency of extreme price movements, an occurrence of sudden and large price movements, a tendency for periods of high volatility to follow periods of low volatility, high levels of correlation among similar types of commodities, and different levels of volatility across different commodities."

Fitch's quantitative analysis is based on its Monte Carlo simulation of the CCO structure.

As for the CFXO report, the first to be published by a rating agency, it details the structure of the product, the principal risks and Fitch's analytical methodology.

"CFXOs are the latest evolution in a trend for the repackaging of market price risk into credit-like synthetic collateralised securitisation structures," said Ken Gill, managing director at Derivative Fitch in London. "Derivative Fitch is working on a number of proposed transactions utilising this structure."

CFXOs combine payoffs linked to forex rates with structural features of synthetic collateralised debt obligations, says Fitch. Typically, the forex risk is wrapped in a funded structure with credit enhancement and risk linked to a diversified portfolio of forex rates. Loss events are set at remote probabilities, similar to deep out-of-the-money options.

In its analysis, Fitch found different levels of historical volatility across forex rates; a high frequency of extreme price movements (fat tails); potential for the occurrence of sudden, large price movements (jumps); and periods of high volatility followed by periods of low volatility (volatility clustering).

The agency has found that asymmetric generalised autoregressive conditional heteroskedasticity, or garch, processes with jumps are able to fit empirically observed features of commodity returns well. The Fitch default vector model, known as Vector, is used to model the correlated risk of the reference portfolio.

Fitch is able to analyse structures that combine forex and credit-default swaps using a combination of its model for forex rates and Vector. JM