SG Corporate & Investment Banking is marketing a constant proportion debt obligation with long and short buckets. The expected EUR150-200 million static deal is unusual in that respect, although other firms, including UBS, also are working on long/short CPDOs (DW, 1/29).
Structurers said the long/short strategy is an obvious next step to long-only CPDOs because it reduces mark-to-market volatility--a leading deterrent for investors in long-only CPDOs--but that progress has been stymied by ratings agencies. Agencies are overwhelmed by proposals for all kinds of CPDOs using long/short, managed bespoke and multi-asset class strategies. Structurers traditionally seek at least one rating from Moody's Investors Service or Standard & Poor's, but said these two are so backlogged that firms including JPMorgan (DW, 1/22) and Barclays Capital (DW, 1/29) are marketing deals rated only by Derivative Fitch.
Officials close to SG's deal, which is its first CPDO, said it is modeled on preliminary guidance from Moody's. Moody's officials did not return calls by press time and SG officials declined comment. It will be similar to the first generation of CPDOs in that it references and rolls with the on-the-run CDX and iTraxx indices. It has an initial long/short ratio of 2.8 to one--long five-year indices and short 10-year indices--which can be adjusted at each roll. This stabilizes mark-to-market volatility and plays on steepening of the credit curve. It also increases default risk, but officials said investors are less sensitive to this because the index roll replenishes the investment-grade portfolio, making CPDOs inherently less risky.
Structurers at other firms agreed that long/short strategies address investors' main concerns, but were skeptical of a static structure. "It's not about default risk," said one rival. "People are staying out of CPDOs because mark-to-market volatility is too high. A short strategy could potentially mitigate that. But the key for any short bucket in any trade is the experience of a manager."
