Credit derivative houses in Japan are closely watching proposed accounting changes which may help draw in a flood of new CDO investors. The Accounting Standards Board of Japan released a draft for commentary at the end of last month on accounting for other compound financial instruments, which discusses excluding AA-rated or higher CDO tranches from mark-to-market accounting. Credit specialists explained many traditional investors have shied away from CDOs in favor of government bonds because of the potential of earnings volatility resulting from the current mark-to-market requirement.
The draft will be closed for comment at the end of the month and market participants expect it to be implemented in the weeks thereafter. "If even a fraction more of regional banks or life insurance companies come into the CDO market, this will be a huge plus," said an official at Calyon. Credit officials expect to see interest for single-tranche global portfolios primarily of U.S. and European names. Ikuo Nishikawa, vice chairman of the ASBJ in Tokyo, did not return calls by press time.
The potential outcome is not all rosy, though. If the changes go through as per the draft, global portfolios will require ratings from more than one international agency, which could drive up costs for the issuers. "This will weigh on dealers' minds," said a credit head in Tokyo, who noted that while costs might go up many more transactions may go through the pipeline. "The big picture is positive but there are still a lot of details to clarify," he added.
There may also be wider-ranging knock-on effects for the CDO market in Japan if the expected changes go forward. Seasoned CDO investors in Japan will start looking at longer-dated structures to pick up yield, rather than migrate down the credit curve. Previously such investors were hesitant about taking longer views on the credit cycle but may find higher-rated seven- or 10-year deals more attractive as a result of the changes.