Standard documentation for single-name credit-default swaps on asset-backed securities will be completed in the next two weeks, which dealers say will boost market liquidity and ultimately foster more tranche synthetic trades and the creation of an index.
A consortium of dealers has been working on a tradable contract on single-name CDS ABS and will be unveiled just ahead of the International Swaps and Derivatives Association template, which the trade association hopes to finish by early May
The lack of a standard contract is regarded as a major impediment to this market's growth. One official said developing the protection buyer side of the market will be the greatest challenge.
The CDS ABS market is dominated by protection-sellers. A JPMorgan research report claims single-name CDS of ABS will transform the ABS market, now primarily long-risk and cash-only, by allowing investors to take on risk synthetically while also letting them short the market and hedge existing positions. Primary protection buyers include dealers hedging their home loan pipelines or hedging out risk they may have from selling protection on a synthetic CDO. The official expects new protection buyers to be hedge funds and other money managers who want to short the market, adding that such players may have been waiting for a standard contract before entering such trades.
James Rothman, a managing director and head of the structured credit group with ACA Capital in New York, said the dealers working on the standard contract will decide whether single-name swaps on ABS should feature pay-as-you-go or physical settlement. "It seems to me the market doesn't know what it wants yet," he said. "What [the dealer consortium] decides will make a dramatic difference on how the market evolves." Rothman advocates pay-as-you-go. So does Charles Pardue, managing partner at Prytania Investment Advisors in London, told DW it's a good way to create a tranched business, which is the direction he said the market must move to be profitable and liquid. Yuri Yoshizawa, a managing director in the derivatives group of Moody's Investors Service, added pay-as-you-go takes out a lot of uncertainty from the settlement process, but has its own pitfalls, such as increased counterparty risk.