[Revived Securitization]②CDS ABCP Issuance Resumes as Profitability Improves

Securities Firms Increase Plans for Credit Derivative Securitization
Large-Scale Issuance Difficult Due to Regulatory Restrictions...Limited Issuance Volume

[Photo by Unsplash]

There is a growing trend of resuming the issuance of credit default swap (CDS)-linked asset-backed commercial paper (CDS ABCP), a type of credit derivative product. Recently, as concerns over a global credit crisis have intensified, the CDS premiums?payments received for taking on CDS protection sell positions?have generally increased, enhancing the profitability of CDS ABCP. Institutional investors are utilizing this as a means to boost short-term investment returns.

Institutions Use It as a Tool to Increase Short-Term Investment Returns

According to the investment banking (IB) industry on the 17th, the number of special purpose companies (SPCs) registered to issue ABCP linked to credit derivatives such as CDS has significantly increased. SPCs such as ‘The First Shining 15th’, ‘Haojun K 5th’, ‘Sky Ocean 1st’, and ‘Need One 18th’ are entities created by securities firms to issue CDS ABCP.

CDS-ABCP is an investment product that increases investment returns by adding the CDS premium to the underlying securitized assets. The lead securities firm transfers bonds purchased in the primary or secondary market to the SPC, then issues ABCP by adding the premium received from selling CDS protection to the bond interest rate. The investment return is higher than that of general bonds securitized into ABCP by the amount of the CDS premium.

Hi Investment & Securities recently established an SPC named ‘Hi Metaverse Surfer 10th’. Through this SPC, they purchased derivative-linked bonds (DLS) issued by Hana Securities and entered into a CDS contract with DB Financial Investment. The CDS contract referenced U.S. sovereign credit risk with a notional amount of 15 million euros. The contract stipulates that if a credit event such as debt restructuring or default occurs involving the U.S. government, the SPC will compensate DB Financial Investment up to 15 million euros.

As compensation for the CDS contract, the SPC received CDS premiums from DB Financial Investment. The SPC pays ABCP investors both the income generated from the DLS and the CDS premiums simultaneously. This allows ABCP investors to earn relatively high investment returns, while Hi Investment & Securities earns some fee income. An industry insider commented, "Due to recent events such as the U.S. Silicon Valley Bank (SVB) incident, CDS premiums have generally risen, enabling a significant increase in ABCP yields through CDS contracts."

The underlying assets are diverse, including not only DLS but also government bonds, public bonds, financial holding company bonds, bank bonds, and specialized credit finance company bonds. The reference assets for CDS transactions are known to frequently involve credit risks of major countries such as the U.S., Japan, and China, as well as domestic and foreign banks. An industry source said, "Recently, CDS premiums for U.S. and European banks have risen significantly. In the past, CDS transactions with relatively high premiums were frequently used to increase yields, but recently, bonds with relatively lower risk are more commonly utilized."

Large Losses if Credit Events Occur in Reference Assets

Although issuance volume has been increasing recently, there are forecasts that securities firms will find it difficult to aggressively expand CDS ABCP due to regulatory constraints. Although MMF balances are growing, there are restrictions on including CDS ABCP in MMFs.

According to the Capital Markets Act MMF collective investment regulations, asset management companies cannot include assets whose principal or transaction amounts increase or decrease due to pre-specified credit events at the time of contract. This measure reflects that MMFs are products intended for customers to temporarily deposit surplus funds rather than active asset growth tools. This is why MMF investment targets are limited to bonds or commercial papers (CP) with short remaining maturities and excellent credit ratings.

CDS protection sell contracts require receiving a certain level of CDS premiums but entail large losses if credit events occur in the reference assets. Most CDS reference assets used in CDS ABCP involve sovereign default risks or financial institution default risks in the U.S., Europe, and major Asian countries, so the likelihood of actual credit events occurring is not high.

Nevertheless, several asset management companies have included CDS ABCP in MMFs and have been fined by financial authorities. An IB industry insider predicted, "Due to regulatory restrictions and negative market evaluations, demand for CDS ABCP will be limited to certain specific money trusts (MMT), unlike regular deposit ABCP."

This content was produced with the assistance of AI translation services.