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Supranational Studies First Use Of Credit Derivatives

The European Investment Bank, a multinational lender with a EUR215 billion (USD192 billion) loan portfolio, is considering using credit derivatives for the first time as a means of hedging its credit risks next year. Officials at the EIB in Luxembourg said the lender is currently conducting an internal review on the credit derivatives market and is weighing whether it makes sense to use products such as single-name default swaps to mitigate risk. "Credit [derivatives] would be a completely new field for us," said Luis Pacheco, an official in the credit-risk department in Luxembourg, noting the bank has used foreign exchange swaps in the past on the back of its bond offerings but has not used any derivatives on its loan portfolio.

The lender hands out EUR36 billion per year, EUR30 billion of which is within the European Union, to highly rated banks and corporates. Two-thirds of the loans go to highly-rated banks with credit ratings in the A range with maturities of 15-25 years, which then loan money to small and medium-sized enterprises. The remaining third goes to corporates across the credit spectrum in five to 15-year tenors.

Pacheco said the EIB will accept default swaps in place of bank guarantees, which it now requires as a means of hedging risk on the bulk of its long-term lending, if the market is deemed liquid enough. Officials were unable to quantify potential usage of credit derivatives given the early stage of the discussions.

Credit derivatives pros were excited to hear of the EIB's discussions. "It's just a matter of time until the credit derivatives market becomes more like the interest-rate swaps market and what we're seeing now is the initial phase," said one trader, adding, "I'm not surprised."

Pacheco and other EIB officials said the reason behind the review is because the default swap market is more liquid and as a result may offer more attractive pricing for debtors. "The advantage is the portfolio approach," commented one official. The EIB has considered using credit derivatives in the past, although it found "the market was not developed enough and so we were not interested," said Pacheco. The supranational is analyzing the market now to see if that has changed in terms of liquidity and critical mass in the last year as is expected. "Now we want to see the new situation of the market and to see if we can use it in our business," he said. He declined comment on potential counterparties. 

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