Post on 05-Jan-2016
Credit Risk transfer
OECD-IAIS-ASSALFourth Conference on Insurance Regulation and
Supervision in Latin AmericaPunta Cana, Dominican Republic, May 6th-9th,
2003Jens Verner Andersen
jva@nationalbanken.dk
2
Outline Profile of credit risk transfer market
Incentives for undertaking risk transfers
Financial stability implications
Concluding remarks
3
Introduction Credit risk transfer mechanisms comprise
a wide group of credit derivatives Transfer risks embedded in credit lending
(corporate loans or bonds) Change financial sector landscape:
Bridging bank and insurance activities with capital markets
4
Introduction (con’d)- building blocks Credit derivatives isolate an entity’s/pool
of credit’s risks risks include bankruptcy, failure to pay
and restructuring of bonds or loans Liquid standardised markets – governed by
1999 ISDA Credit Derivatives definitions
Reference entity
Protection Buyer Protection SellerPremium
Contingent payment on default
5
Credit derivative Volumes – 1996 to 2004
0
1000
2000
3000
4000
5000
6000
1996 1997 1998 1999 2000 2001 2002 2003 2004
Notional value volume Source: 2001/2002 BBA Credit Derivatives Survey
Billion USD
6
Maturity Profile of Market at Trade Inception
0 5 10 15 20 25 30 35 40 45
Over 10 years
5-10 years
5 years
1-5 years
3-12 months
1-3 month
per cent
Source: 2001/2002 BBA Credit Derivatives Survey
7
The Product Universe
Single name credit default swaps
Portfolio/CLOs
Credit-linked notes
Total return swaps
Asset swaps
Credit spread options
Basket products
Source: 2001/2002 BBA Credit Derivatives Survey
8
Who buys
0
10
20
30
40
50
60
70
Banks
Securities Houses
Hedge Funds
Corporates
Monoline Reinsurers
Insurance Companies
Mutual Funds
Pension Funds
Government/Export agencies
End 1999 End 2001
Per cent
Source: 2001/2002 BBA Credit Derivatives Survey
9
Who sells
0
10
20
30
40
50
Banks
Securities Houses
Hedge FundsCorporates
Monoline Reinsurers
Insurance Companies
Mutual Funds
Pension Funds
Government/Export agencies
End 1999 End 2001 Source: 2001/2002 BBA Credit Derivatives Survey
Per cent
10
Net sale of credit protection
-200
-150
-100
-50
0
50
100
150
200
250
Banks
Securities Houses
Hedge FundsCorporates
Monoline Reinsurers
Insurance Companies
Mutual Funds
Pension Funds
Government/Export agencies
End 1999 End 2001
Billion USD
Source: 2001/2002 BBA Credit Derivatives Survey
11
Factors generating growth- protection buyers Capital optimisation:
Increased focus on capital charges as an integral part of credit lending
Risk/return Improved risk management options:
Sector Geographic
Retain commercial clients: without having negative concentration impacts Preserve relationship discount
Regulatory capital relief
12
Factors generating growth- protection sellers Enhancing yields: Decline in interest rates
across the board in combination with lower supply of sovereigns have increased end-investors’ demand for new instruments.
Return on Capital: Deploy capital more efficiently - obtain higher risk adjusted returns.
Excess capital in the insurance sector Leverage expertise and brand in related
businesses
13
Value added in insurance companies Separating value creation into two entities:
Insuring risks: Issuing insurance contracts that more than cover the associated production costs, including capital cost.
Investing cash from premiums until claims are paid: Achieving an investment result that beats the benchmark on a risk-adjusted basis.
Insurance companies focus on shareholder value by:
Managing capital more efficiently: constrain capital to business generating sufficient profit.
Risk transfer techniques: Credit enhancement is innovative use of surplus capital.
Apply basic underwriting skills in related areas
14
Factors generating growth- market factors New product types - Not only a hedging
device Structured products enhance liquidity in
credit derivative markets Broader investor interest Continuous price setting in largest credit
types in electronic systems (eg. Bloomberg)
15
Financial stability implications Regulatory arbitrage
Regulatory Capital Accounting
Learning curve risks Complex business on the borderline between
banking and insurance: Do market participants understand risks?
Risk management Adequate pricing and proper valuation are
demanding but important when risks crystallise. Counterpart exposures may still exist An integral part of corporate culture
16
Transparency and disclosure Lack of transparency Rating agencies play a special role Fitch Ratings special report: Global Credit
Derivatives: Risk Management or Risk Consumer protection issues
New types of risks have been transferred to small investors in CIS type schemes, variable annuities, and DC pension schemes
Pay more attention to aspects related to final consumers
Financial stability implications (cont’d)
17
Concluding remarks Potential benefits from credit derivatives:
Risk transfer markets offer opportunities for improved risk management.
Facilitate more manageable credit- and insurance cycles as deployment of capital is improved.
Depends on management of new risks Capital market innovation is a challenge for
users and authorities. Capital market integrity issues related to
accounting, capital and consumer protection Enhanced transparency is needed