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The proposed Basel capital adequacy accord will likely close a loophole that allows structurers and investors to arbitrage rating agencies in order to get a desired rating for collateralized debt obligations. Rating agencies assign different ratings for the same obligations because their methodologies and projected default curves are different. Investors and structurers are aware of this and frequently ask Moody's Investors Service to rate the lower tranches of a deal and Standard & Poor's or Fitch Ratings to rate the higher tranches.

CIBC World Markets is planning to start offering synthetic collateralized debt obligations in Japan next year. Yasuhiko Kai, fixed income trader at CIBC in Tokyo, said the plans are in response to a growing number of domestic banks looking to remove credit risk from their balance sheets, in addition to more investors wanting higher returns than traditional fixed income instruments offer.

The Province of Ontario has entered two swaps to convert a USD250 million fixed-rate bond into a Canadian floater, and then into Canadian fixed-rate. Gadi Mayman, executive director in the capital markets group, said the province receives a fixed-rate and pays a LIBOR-based floating rate in the first swap. The LIBOR-based rate was then traded for Canadian bankers' acceptances, which were paid out in exchange for a Canadian dollar- denominated fixed rate, he said, declining to specify the rates.

A synthetic arbitrage collateralized debt obligation is originated by collateral managers wanting to exploit differences in yield between the underlying assets and that payable on the CDO. The generic structure is as follows: a specially-created special-purpose vehicle enters into a total-return swap with the originating bank or financial institution, referencing the bank's underlying portfolio. The portfolio is actively managed and is funded on the balance sheet by the originating bank. The spv receives the total return from the portfolio and in return it pays LIBOR plus a spread to the originating bank. The spv also issues notes that are sold to CDO investors.

Five-year credit protection on U.S. communications giants, including cable TV operator Comcast and Cox Communications, moved in by around 100 basis points last week, as the market experienced a renewed appetite for credit. Five-year default swaps on Comcast narrowed to 390 basis points last Wednesday, in from 515bps the previous week.

The Federal Reserve Bank of New York invited more than 60 representatives from the largest credit derivatives houses in the U.S., including Ambac Assurance Corp, Bank of America, Citibank and JPMorgan, to its Liberty Street offices for the first time on Oct. 24 as part of a review of whether banks need restructuring protection to get regulatory capital relief. Darryll Hendricks, senior v.p. at the Fed in New York, said the regulator has to take account of market implications in developing policy and is actively considering its stance on restructuring and capital relief, including its position on what should be included in the proposed Basel capital adequacy accord. However, he added that the main purpose of the meeting was to understand what is going on in credit derivatives, rather than to discuss regulatory proposals.

Agence Française de Développement, France's principal project aid agency for lending to developing countries, has entered an interest rate swap to convert a recent EUR500 million (USD493 million) bond into a floating-rate liability. In the swap, the agency receives the 4.75% coupon on the bond and pays a spread over six-month Euribor. Gregory Clement, funding manager in Paris, said the agency typically uses interest rate swaps to convert its fixed-rate debt into floating-rate to match its lending portfolio. The agency also uses interest rate swaps to alter the duration of its debt.

Interest rate swap traders and analysts are predicting European swap spreads could tighten further by year end, with Deutsche Bank going as far as saying that 30-year swaps could trade tighter than the 30-year German Bund within the next six to 12 months. Swap spreads are at their tightest level for a year, with the 10-year swap spread trading at 20.5 basis points over the German Bund, in from 28bps at the beginning of October and the five-year tightening to 25.5bps from 31.5bps within the same period. Strategists said the main reason for the predictions is anticipation of massive long-term bond issuance from sovereigns due to looming budget deficits. Although this would initially affect the long-end of the curve, swap rates are usually correlated so the whole curve should tighten. Another reason for tightening is unwinding of long asset swap trades, where investors are long cash bonds and are paying swaps.

Equity derivatives players in Hong Kong are up in arms about upcoming financial regulatory changes because they could hinder liquidity in the over-the-counter market and be expensive to implement. "[The Securities and Futures Commission is] really trying to clamp down on market manipulation, but this could drive away liquidity," said Ali Ahmed, head of equity derivatives trading at ABN AMRO in Hong Kong.

The International Swaps and Derivatives Association has released its fifth and final draft of the 2002 master agreement and is asking its members for comments by Nov. 11. Kimberly Summe, general counsel at ISDA in New York, said in an e-mail to ISDA members that the group would circulate a pre-publication draft at the end of November and publish the new agreement by year end.

The International Swaps and Derivatives Association is planning to unveil the final draft of the 2002 equity derivatives definitions within the next week, with the intention to seek comments by Nov. 15 and publish the final document before year-end.