Swap counterparties in deals rated by Moody's Investors Service may see the amount of collateral they're required to post decrease, thanks to new guidelines the rating agency plans to adopt.
Cash flow deals issued after Sept. 1, which have not modeled additional expected losses that could stem from a counterparty and are rated at least Aa3', will be able to operate under the new guidelines.
The change will essentially allow structured finance transactions to separate themselves, or "de-link" from the ratings of their hedge counterparties - a move which will help protect investors from the risk of a counterparty downgrade, according to the rating agency. In order to allow for the separation, Moody's will require that counterparties agree to a set of rating triggers and remedies prior to the deal's close.
Previously, counterparties pledged a variable amount of money in order to maintain the transaction's rating. The change will allow for a more accurate estimate of the cost of posting collateral or of counterparties needing to replace themselves, according to Moody's. That means that some banks and insurers could end up posting less collateral than had been required in the past, the rating agency said.
"By modeling the hedge's likely contribution to a deal's expected loss, we have developed a dynamic, real world approach to quantifying the collateral that should be posted by a counterparty in the case of a credit event," said Nicolas Weill, a managing director at Moody's and chief credit officer of the structured finance group.
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