While derivative product companies - essentially highly rated swap counterparties - have been around for years, the new thing is the surge in the number of such entities in the pipeline, said market participants from the various panels at the recent Information Management Network Barcelona summit.
Industry experts predicted that as many as a dozen of these companies would pop up in the near future. This shift is expected to provide a new wave of liquidity to the credit derivatives market. A number of the companies are also looking to obtain banking licenses, a step that would make them a more lucrative counterparty to entities previously constrained by red tape from working with them.
For more than a year, Standard & Poor's has been working with as many as 12 groups across the U.S. and Europe that are looking to set up a DPC, according to Katrien Van Acoleyen, a managing director and head of European CDOs and credit derivatives at the rating agency. Participants in the sector include such companies as Primus Guaranty and Athilon, which completed its first such deal last year. Primus was largely considered the first DPC to enter the credit derivatives market when it opened in 2002. Nick Proud, a managing director at Assured Guaranty, said he knows of as many as eight more that are seeking credit ratings from the rating agencies.
The DPCs, which typically hold a triple-A rating, are gaining more interest from hedge funds and investment banks looking for a new way to make money on the burgeoning credit derivatives market. As credit derivative notional amounts grow along with the range of assets referenced, so does the need of protection buyers for highly capitalized sellers with an appetite for risk, market sources said. "I think what people are finding is that they are happy to have a triple-A counterparty in this market," Proud stated.
Juan Blasco, a director in BBVA's capital markets, is expecting the companies to have a "huge impact on the market, parallel to what (Structured Investment Vehicles) did." Blasco noted the company is aware of a dozen looking to start up, primarily out of the New York City market, although several have also cropped up in London.
Arguably one of the most appealing aspects of the DPCs is that they are not required to mark their positions to market. They also have a wide range of leverage available, depending on the structure, and do not have to post a margin.
The structures, however, are expensive to put together. Blasco estimated the typical DPC will be coming to market with about $500 million in equity capital. Primus is armed with about $400 million, while Athelon has more than $600 million. The ratings are complex, melding together both corporate credit and structured finance ratings, according to S&P's Van Acoleyen - an aspect that adds to the time consuming nature of setting up such a vehicle. Thus their entrance is not expected by some to have quite the impact that the hedge fund entrance, for example, had on the credit derivatives market, according to some panelists. "It is a very narrow type of animal," Van Acoleyen said.
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