With the blessing of a triple-A rating from Moody's Investors Service, hedge fund Aladdin Capital Management became the proud parent of the newest credit derivative product company on the block. The road to obtaining a CDPC rating is a long, drawn out process, sources said - but demand certainly seems strong enough to obtain one.
The rating agency said last week that it is sifting through 24 proposals for CDPCs, and that it is likely to rate several in the first half of the year. CDPCs are essentially a stand-alone business, so models vary. CDPCs typically act as highly rated counterparties in credit default swaps, although their activities range from single-name swaps to an area that makes monoline insurers uncomfortable - selling protection for highly rated CDO tranches. By and large, most of the proposals before rating agency analysts involve selling credit protection via either single-name swaps or CDOs referencing corporate credit.
The reason is twofold. The lower on the rating scale a CDPC opts to offer credit protection, the more capital it has to maintain. Also, securing rating agency approval for a business that initially intends to write protection on ABS is challenging because of the more complex and relatively untested nature of ABS credit default swaps, not to mention their long duration.
While sources say it's unlikely all of the 20-plus proposals in rating agency pipelines will translate into CDPCs, the introduction of Aladdin's CDPC, along with such CDPCs as Babson Capital Management's Invicta Credit LLC and Deutsche Bank/AXA Investment Management's anticipated Newlands Financial this year has market participants questioning whether they will be "scrambling for product," especially in light of the growing CPDO bid.
Yet CDPC developers counter that the rapidly growing credit derivatives market, both in size and in diversity of collateral referenced, begs the need for a triple-A rated counterparty that is flexible enough to move with the market. As one CDPC source put it, there is a growing gap between what monoline insurers are able to provide structured finance players and what the market needs.
The majority of proposals before Moody's are for U.S. entities, although a quarter are European. Half of the new CDPCs are proposals from asset management firms, while the rest are bank and insurance companies, Moody's said last week. The majority of CDPCs going forward are expected to be extensions of existing operations. For asset management firms, growth into the CDPC business can be done leveraging resources from other lines of business such as CDO management. For example, Babson's Invicta CDPC only has three full-time employees, offering a sizable cost advantage over the CDPC market's pioneers when these first started up.
And lastly, just because a CDPC is assigned a rating doesn't mean it hits the ground running. According to one source, several rated CDPCs have yet to get started in the game.
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