CDO managers are considering setting time limits for triggering credit protection in order to increase transparency and appease investor concerns. The move is sparked by confusion over why some protection buyers recently have started to trigger contracts referenced to U.S. chemical company Solutia even though the restructuring credit event occurred last year.
Both European CDO manager AXA Investment Managers and U.S. manager Deerfield Capital Management are considering putting time limits in upcoming deals. Laurent Gueunier, head of investment grade CDOs at AXA in Paris, suggested that a limit of six months to a year would work. Some investors, however, called for limits of around three months, with one saying 30 days is all investment banks should need. "If the buyer of protection cannot prove it is a credit event within a couple of months it is probably a dubious credit event," said one investor.
The problem with including a time limit in CDOs is that it introduces basis risk for the structuring firm. The worst case scenario for the structuring house would be if the protection it bought to hedge the CDO was triggered after the time limit for triggering contracts in the CDO had elapsed. This would leave the bank unhedged. One banker said he would be open to structuring such deals but it would reduce the spread as the bank would have to be paid to take this risk.
In addition, the time limit would aid rating agencies in their surveillance of deals because possible credit events would not be left hanging over deals.
"On the face of it, limiting investors' time exposure would be a benefit to investors and rating agencies," according to Ebo Coleman, senior credit officer at Moody's Investors Service in London.
