The recent emergence of a balanced collateralized debt obligation market has made dealers less exposed to a major correlation re-pricing event, structured credit traders say. Usually, dealers are forced to hold large portions of short correlation positions, typically in equity, on balance sheet because there is no one willing to take the other side of a hedge. But recent investor appetite for innovative equity-linked structures (DW, 6/9) has meant dealers are able to offload equity and reduce the risk of losing out when unexpected correlation shifts occur.
Dealers declined to put a figure on the notional of shorts now covered, but said this will continue as long as there is enough value in the first-loss piece to attract investors. One trading official said activity in leveraged senior and super senior has also contributed to the more equal number of CDO buyers and sellers (DW, 7/7).
In the past, firms have taken huge hits because of their short correlation exposure. In May last year, a number of structured credit trading books across the Street were rumored to have suffered USD100 million dollar-or-more losses when Ford Motor Co. and General Motors Corp. were downgraded and they were caught with naked shorts they were unable to unwind.
