CDS on ABS set for growth as documentation and sentiment improves

Asset-backed security (ABS) derivatives look set to gain increased popularity, firstly following the release of a template for ABS credit default swap (CDS) trading by the International Swaps and Derivatives Association, and second due to various bankers saying the underlying ABS market is likely to exhibit growth this year.

ABN Amro’s head of consumer ABS, Steve Curry, said the widening of corporate bond spreads over the past few months had driven some investors to the firmer ABS paper. ABS spreads widened only 4-5 basis points in some cases, compared with 40-50 basis points for some corporate bonds in the wake of the Ford and General Motors downgrades. This advantage may bring more investors and issuers to the ABS market, Curry said.

The publication of a template for trading CDS on ABS will also encourage more trading, Isda said. The template, released yesterday, is intended to document CDS on ABS intended for cash or physical settlement; Isda plans to publish another for pay-as-you-go settlement later this month. The trade association’s chief executive Robert Pickel said: "The continuing growth in the size and product range of credit derivatives is opening up this important asset class to an ever broader range of investors. Providing robust legal and documentation solutions to support this evolution is fundamental to our mission."

Christopher Flanagan, managing director of ABS research for JP Morgan, said last month that the emergence of CDS for ABS was “a major development in the evolution of the ABS market”, allowing investors to take on risk synthetically for the first time, short the market or hedge their existing positions. At that time he said there were two obstacles to the market’s growth. One was a lack of investor base, which according to Curry is now improving; the other was the absence of standard documentation. Isda’s work should address this issue.