LOS ANGELES - Despite the phenomenal surge in asset-backed securities credit derivative issuance, some West Coast market participants say they are wary to jump into either the single name or index markets until the sector can offer more stability. While some are choosing to dip a foot in, others are staying out completely.
Several attendees at the American Securitization Forum's first-ever Los Angeles Sunset Seminar held here last week said they were either wary or unable to use ABS CDS as a hedging tool due to "unquantifiable" risk involved in the market. A number of CDS contracts, for example, have ended up in arbitration or in legal proceedings (see article Page 1) and the ABS CDS market has yet to agree on standard documentation. Employees of GE Consumer Finance subprime mortgage unit WMC Mortgage Co., for example, were interested in gathering more information about using ABS CDS as a way to hedge the company's mortgage pipeline - but the company's uncertainty on the swaps has so far kept it from entering into any agreements, they said.
And as it has stated before, the ever-cautious Newport Beach, Calif.-based asset manager Pacific Investment Management Co. has refrained from putting on any large-scale trades using ABS CDS. "I will say that we still remain very cautious on the long-term viability of this market," said PIMCO senior vice president and portfolio manager Josh Anderson. "I'm not convinced that the liquidity is going to be here in the long term," he said. As a result, Anderson said the firm is not buying into any contracts that they don't anticipate holding until maturity.
At the brunt of Anderson and others' concerns: How or if CDS counterparties will end up settling their trades once large-scale credit events begin to occur. Various contracts, templates and documentation have changed and updated a number of times at the hands of various groups - primarily the International Swaps and Derivatives Association - yet a so-called standard template for ABS CDS trades that will move the sector toward more objective confirms is still in the works.
"It is a little difficult for me to understand why the standard documentation and template have not come together more quickly," said James Wallin, a senior vice president at Alliance Capital Management, pointing out that disputes over templates and confirmations should be dealt with now before the market triples or quadruples in size - or experiences a substantial credit event. PIMCO's Anderson pointed out that a number of dealers already have a substantial amount of money on the line through the ABS CDS market, and they are not willing to budge if it means altering the desired outcome of the trades they've put on.
The CDS market, in general, has made strides toward the nearly exclusive use of electronic transactions - a trend that will lead into what the Depository Trust & Clearing Corp. hopes will be a comprehensive database, or "warehouse," of trades. The company is developing a central trade information warehouse that would maintain records of each contract, as well as maintain a central processing function that would standardize and automate payment and other post-confirmation processes.
While electronic transmission of corporate CDS is up-and-running through the DTCC's system, a uniform format for the more wily ABS CDS, as well as the loan CDS market, is still in the works. According to its administrators, if dealers begin to back load trades into the warehouse this year, the system will be implemented in mid-2007.
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