While collateralized debt obligations in Europe have been predominately balance-sheet deals, arbitrage deals are on the rise, promising to eclipse all of 2000's cashflow-deal issuance by mid-year, sources said.

Currently there are at least five European asset arbitrage deals circling the U.K. market, investors said. This is compared to just seven high-yield CBOs out of Europe last year, and one deal in 1999.

Though the market is looking at a strong start for the year, there are a number of issues - such as diversity scoring and cross-border legal implications - which will keep the growth in check, compared to last year's $30 billion U.S. arbitrage market (figure provided by Standard & Poor's).

"This is clearly something that is coming to the European market," said Detlef Scholz, a managing director at the London-based office of Moody's Investors Service.

"However, the great challenge when you're doing a deal in Europe is to reach diversity requirements."

Because Europe's high yield market is heavily concentrated in the telecom sector, issuers looking to package assets have been creative. Last year, when the first few European arbitrage deals were hitting market, managers were including buckets for U.S. credits (see ASR 4/17/2000, p. 3).

"It's been fairly difficult to use just European assets at this point in time," Detlef said.

Another strategy is to include slightly better credits in the pools on a deal's offset, such as bonds in the triple-B range, which afford managers the time to locate the sought-after higher yielding bonds.

Beyond diversity, the different legal environments in the various countries often pose challenges to collateral managers.

For instance, Cabral No.1 Limited, a deal that has been circulating the past few weeks, includes bonds from Portugal, as well as other euro-bonds.

The deals typically have a longer ramp-up period than their U.S. counterparts. Still, difficulty in finding collateral has not yet stopped a deal form getting done.

Another view

Although welcomed by most, at least one investor thinks that the advent of CDOs will be detrimental to Europe's emerging high yield market, arguing that CDOs will infringe upon the high yield learning curve.

"I think it does reflect the fact that people can't actually make credit decisions, one by one," the investor said.

"They've just got to say, let's buy the whole bloody thing. I'm not sure that's the best way to do it."

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