Swelling volumes of U.S. CDO issuance have drawn more intense regulatory scrutiny and raised the need for standardization across both cash and synthetic sectors, market participants say. In the cash flow segment alone, CDO volume is up 65%, to $55.1 billion, so far this year compared to last year's record numbers. And as the credit derivatives market catapults growth within the CDO sector, more communication, and some say more regulations, are needed.
"The market has gone through different stages of growing pains," said Louis Lucido, group managing director at the Los Angeles-based money manager Trust Company of the West. Lucido is also the newly appointed head of the American Securitization Forum's CDO manager subcommittee, a group that was announced last week, he added: "We've seen it evolve and morph and change since its inception, and now that we approach a trillion dollar market, we want to make sure there is a continuity in its evolution, and an opportunity to broaden the depth and breadth of people participating in this market - and we want to be catalysts for that."
Lucido, with the help of deputy chair Chris Ricciardi, the CEO of Cohen Brothers, is hoping to spearhead communication across the CDO sector - including fellow managers, investment banks, rating agencies, regulators and others. The pair is planning to set up a steering committee with industry participants. "We want people to be active on this - not to just think this is a part-time thing just to give lip service to," Lucido said "We want people that are actually going to be actively involved with us and moving ahead." Projects like collaborating with the International Swaps and Derivatives Association to further the goal of standardized documentation across the burgeoning credit default swap market is of particular interest to the new committee, he said. One project on the horizon is the creation of standardized documentation for CDS of CDO trades.
CDO investor base broadens
On April 25 the Bank for International Settlements will hold a meeting in New York, hosted by the Federal Reserve, titled Structural Change in Credit Markets.' Afterwards, the Office of the Comptroller of the Currency's National Risk Committee will meet for two days. The regulatory agencies have asked structured finance professionals with knowledge of the CDO and derivatives markets to address topics such as market size, risks and trends. Janet Tavakoli, president of Tavakoli Structured Finance, was asked to address the unquantifiable risk present within the derivatives market at the Federal Reserve meeting - a topic that holds particular interest for regulators, she said.
"Based on what I've been able to see - I'll go to private equity funds or new investors that have never invested in a CDO that think this is a great deal,' but great' relative to what?" Tavakoli said, "Salesmen are encouraged not to over-educate their investor. This is not a new story in the finance business. We see this with every new and sophisticated product where investors can take out their fees."
Investor appetite for CDO products - such as constant proportion portfolio insurance, leveraged super senior tranches, and equity pieces - has increased around the globe as a low U.S. federal funds rate, among other factors, has sent excess cash in search of yield. Overall global CDO issuance grew by 59% in 2005, to $250.9 billion from $157.4 billion in 2004, according to Thomson Financial. Meanwhile, roughly $6.4 billion worth of global synthetic CDOs have come to market so far this year, along with some $65 billion in cash issuance, Thomson reports. And, according to some estimates, total outstanding global cash and synthetic deals represent more than $1 trillion in total notional value.
Banking regulators - which could move to increase banks' regulatory capital requirements, or the amount of cash they must have on hand in proportion to perceived risk - don't seem to hold as much clout within the financial community as the Securities and Exchange Commission, according to Tavakoli. That's because unlike the banking regulators, the SEC has comparatively more teeth in levying fines and taking other action, she added. For example, both the SEC and New York Attorney General Eliot Spitzer last July announced they were investigating Bear Stearns' CDO trading practices with clients.
The SEC's Miami office had recommended enforcement action against Bear for its involvement in the pricing, analysis and valuation of some $62.9 million of CDOs it sold to one of its clients, Bear disclosed in a 10-Q filing. The investment bank also received a subpoena from the Attorney General's office asking for information related to roughly $16 million of CDOs purchased by one of its clients, according to the filing (ASR, 07/18/05)
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