The African Development Bank is considering using credit derivatives for the first time to hedge counterparty exposure on its USD5.5 billion (notional) interest rate and foreign exchange swap portfolio. The bank, which is rated AAA by Moody's Investors Service and AA plus by Standard & Poor's, enters interest rate swaps on all of its fixed-rate bond offerings, according to Thiebaut Julin, division manager of capital markets in Paris.
ADB is also looking at both buying and selling credit derivatives for its USD3.4 billion investment portfolio, according to Julin. An official in the asset-liability division said this would not be in the immediate future, but declined further comment. Hassatou Nsele, official in the funding division in Paris, said the development bank's investment portfolio consists of commercial paper, short and medium-term bonds and money market funding.
"It is absolutely clear that credit derivatives offer an interesting opportunity to hedge counterparty exposure in a swap portfolio," said Nobby Clark, head of structured credit trading at HSBC in London. One strategy, he said, could be to buy bespoke protection on the mark-to-market value of a swap instead of buying a standard contract on a counterparty. He cautioned, however, that credit derivatives are not the only way to mitigate counterparty exposure and it is necessary to fully understand a client's whole portfolio before deciding on a strategy.
Julin said ADB had not yet begun to speak to derivatives houses about these instruments. "We are still in the preliminary stages," he added, declining to elaborate on what the bank would look for in potential counterparties. It makes a lot of sense that the agency would be thinking about reducing counterparty exposure, since there is currently a lot of concern about banks' ratings dropping further, said one credit derivatives marketer. He added that he would definitely be interested in going after the business.
