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Risk transfer deal transfers risk

By Owen Sanderson
18 Jan 2018

Risk managers are already turned on to the benefits of balance sheet CLOs — if arrangers and investors in this intensely private market are to be believed, almost every large institution in Europe has been looking at issuing these deals. But they still leave a nasty taste in some mouths.

The fact that HSBC’s loan to Carillion turned up in a balance sheet CLO issued in 2015 can only confirm the benefits of the product.

With no public debt and no single name CDS market, hedging the credit risk would have beeen nigh on impossible.

With a synthetic deal, HSBC is covered for $72.5m of Carillion exposure — and the deal, Metrix, still has $227.5m of protection in the tank, in case another UK name goes south. The bank won’t release details on who sold the protection, but it’s certainly out of the banking system, and so much the better.

But deals like this still come with cultural baggage. Terms like synthetic, capital relief, CLO and CDO put regulatory hackles up — and, to be fair, the deals are done at year-end specifically to flatter year-end balance sheets.

The ECB, as supervisor, is signing off the deals, but the European Commission continues to give them a hard time. From 2019, new deals will have a higher hurdle rate before they achieve significant risk transfer status — the holy grail for bank issuers, which allows them to claim capital relief. The senior tranches, which stay on bank balance sheets, also come with high capital costs.

Deals must genuinely pass on risk, but if they do, then it should be full steam ahead. The hedge funds which play in this market need no hand-holding. Regulators should applaud when they make European banks safer.

Risk transfer is what capital markets are supposed to do, however complex the deal might appear. Dry Januarys notwithstanding, let’s raise a glass to HSBC’s Carillion hedge.

By Owen Sanderson
18 Jan 2018