| David Clementi | ||||||
David Clementi, deputy governor at the Bank of England, says the use of credit derivatives in securitization poses a threat to capital market stability.
In the closing address to the International Bond Congress in London, Clementi surprised borrowers, investors and bankers with his concerns at the rapid growth of credit derivatives and ABS markets, which many banks hope compensate for the shrinking returns in bond trading and underwriting.
Clementi said there was a danger of a lack of transparency in the market, because of the increase in the use of synthetic CLOs, where the risk attached to loans and bonds is sold on without a sale of the assets.
“These markets mean that a bank need no longer remain exposed to its main customers but can rapidly take on large exposures to other credits without any new borrowing by the underlying entities,” he said.
Clementi said it was a major challenge for authorities such as the Bank of England or the Federal Reserve to keep pace with the rapidly changing world of securitization and derivatives in collecting financial statistics.
He also fears not all investors understand securitization. “Some participants in this market may not fully understand, or may have differing understandings of, the transactions into which they have entered,” he said, adding that uncertainties remain about how courts in different countries will treat covenants and agreements in credit derivative deals.
The case of LTV Steel illustrates his concern. LTV is battling Abbey National in the US over ownership of assets securitized in a deal. The judge appears to favour LTV, though Abbey National says it will appeal if it loses.
Investors, because of this risk, have to make sure they have conducted due diligence, said Clementi.
The merging of the lending, securities and insurance markets raised new risks, he said, adding this risk was particularly evident now due to the debate over whether restructuring of debt constitutes a credit event, thereby triggering a credit default swap. This row was sparked when Conseco restructured its debt late last year. The International Swaps and Derivatives Association has convened meetings to try and find agreement on this question.
The British Banking Association has predicted that the credit derivatives business will triple from $586 billion in 1999 to $1.581 billion in 2002. This item first appeared at www.euromoney.com/bonds.
