Derivative Fitch outlines views on collateralised FX obligations

Derivative Fitch has published its considerations for analysing and rating collateralised foreign exchange obligations (CFXOs). The CFXO report, the first to be published by a rating agency, details the structure of the product, the principal risks and Fitch’s analytical methodology.

“CFXOs are the latest evolution in a trend for the repackaging of market price risk into credit-like synthetic collateralised securitisation structures,” said Ken Gill, managing director at Derivative Fitch in London. “Derivative Fitch is working on a number of proposed transactions utilising this structure.”

CFXOs combine payoffs linked to forex rates with structural features of synthetic collateralised debt obligations, says Fitch. Typically, the forex risk is wrapped in a funded structure with credit enhancement and risk linked to a diversified portfolio of forex rates. Loss events are set at remote probabilities, similar to far out-of-the-money options.

In its analysis, Fitch found different levels of historical volatility across forex rates; a high frequency of extreme price movements (fat tails); potential for the occurrence of sudden, large price movements (jumps); and periods of high volatility followed by periods of low volatility (volatility clustering).

The agency has found that asymmetric Garch processes with jumps are able to fit empirically observed features of commodity returns well. The Fitch Default Vector Model (Vector) is used to model the correlated risk of the reference portfolio.

Fitch is able to analyse structures that combine forex and credit-default swaps using a combination of its model for forex rates and Vector.