Collateralized debt obligation professionals are requesting Standard & Poor's rate structures that give them more discretion to trade long/short strategies. Nik Khakee, director in New York, explained that while many structures already allow managers to take short positions, these are typically restricted to buckets of 5%-10% of the deal. Managers are increasingly seeking to break out of these restrictions, which is encouraging more discussions on how this may be achieved in rated deals, he said.
One solution may be to create trading buckets funded with extra capital, in which CDO managers can execute long/short and relative value strategies, said Khakee. In this system the manager would typically implement stop-loss triggers under which the trading strategy could not be continued once a predetermined amount of capital was lost, he said.
The trading bucket would need to comprise additional capital, rather than being deducted against the deal, as there is no data to support an assumption that a manager is guaranteed to make money in the strategy, which would otherwise be implied in a AAA rated structure, he explained. Other factors needing to be considered when rating such structures include the success rate of the managers as relative value traders and counterparties for trades.
