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Much has been written about the implosion of the structured credit markets and the impact on a variety of different types of structured credit vehicles, many of which have collapsed. However, little attention has been paid to one type of vehicle that has successfully weathered the storm: a credit derivative product company ("CDPC"), which now occupies a small but growing position in the $62,173 billion credit derivatives market, at December 31, 2007 (source: ISDA annual market survey).
The first CDPC commenced business in 2002, and there are now nine triple-Arated CDPCs. In addition, approximately 10 more CDPCs are in various stages of formation. All take or are expected to take corporate credit risk; some take just single name risk, others take solely tranched credit risk as explained below, and a few may do both. In addition, some CDPCs have taken ABS risk. Market estimates put the total notional protection sold by CDPCs in the $100 billion range, still a fraction of the overall credit derivative markets.
This article provides some background on CDPCs that focus on corporate credit risk and contrasts their attributes with those of other structured finance vehicles in general and those of financial guaranty insurance companies (so called "mono-lines") in particular, to explain why the business model is robust.
WHAT IS A CREDIT DERIVATIVE PRODUCTS COMPANY?
A CDPC is a triple-A rated entity that is a net seller of credit protection in the form of credit default swaps ("CDS") referencing corporate, sovereign, municipal, or assetbacked obligations ("reference obligations"). In a typical CDS, in exchange for a premium, which is typically paid quarterly in arrears, a CDPC agrees that it will pay the protection buyer (the "counterparty") upon a credit event that affects an underlying reference obligation. However, while some CDPCs have taken ABS risk, most are restricted to corporate reference obligations (either on single names or tranches of underlying pools of corporate credits). This article focuses on those CDPCs whose focus is corporate credit risk.
CDPCs were created in response to the rapid growth in the credit derivatives market, which drove the need for a new type of credit investor that could:
* Take credit risk in credit default swap form; and
* Absorb the Mark-to-Market ("MTM") risk arising from the...