Fitch Criteria: Credit DPCs ‘An Important Step’ for Credit Derivatives
NEW YORK — Though still a ‘new face’ to the credit derivative markets, credit derivative product companies (CDPCs) are rapidly making a name for themselves, according to a new criteria report by Fitch Ratings.
Fitch has provided Issuer Default Ratings (IDRs) and liability ratings for CDPCs, which are limited purpose operating companies that provide credit default protection on corporate obligors, asset-backed securities (ABS), tranches of collateralized debt obligations (CDOs) and synthetic CDOs. And with several additional credit DPCs in the pipeline, Fitch sees the emergence of these companies as an important step in the continued development of the credit derivatives market, according to Senior Director Alan Dunetz.
‘Credit DPCs have the ability to raise permanent equity capital and can sell credit protection on highly rated obligors to multiple counterparties on an ongoing basis,’ said Dunetz. ‘The appeal for credit DPCs can in part be attributed to their focus on CDS and their ability to operate independently of their sponsors, as opposed to traditional derivative product companies that concentrate largely on interest rate and currency swaps and options.’
Though credit DPCs are designed to manage credit risk by selling credit default protection, they may also be susceptible to market risk, as well as interest rate, prepayment, and FX risk, all of which are accounted for in Fitch’s analysis. Credit DPC management is another core component in Fitch’s methodology as, according to Dunetz, ‘members of both management and the board of directors to have extensive backgrounds in structured credit, structured finance, derivatives, and credit risk management due to the complexity of these vehicles.’
Though credit DPCs are similar to managed synthetic CDOs in that they both sell protection on actively managed portfolios of reference obligations, the similarities end there because while managed synthetic CDOs have a fixed maturity date, credit DPCs are set up to be permanent companies with broader operating flexibility, as well as the potential to access the public market for funding, as has the first such company, in the form of an initial public offering (IPO).
Fitch will hold an investor conference call in the coming weeks to discuss the report (separate release to follow). ‘Criteria for Credit Derivative Product Companies,’ is available on the Fitch Ratings web site at www.fitchratings.com.
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