Fitch to investigate credit derivatives risk concentrations

Credit rating agency Fitch Ratings is concerned that the rapid growth and lack of transparency in the synthetic credit markets could be leading to alarming concentrations of risk with specific market participants.

Fitch said it would conduct a survey aimed at gaining a better understanding of the concentrations of credit risk in the market, with a special focus on the sellers of protection. It added that insurers and reinsurers have rapidly emerged as key sellers of credit protection.

“The rapid growth, lack of transparency and relative immaturity of the [synthetic credit] market… warrants closer review, particularly for unanticipated concentrations of credit risk,” said Fitch in a statement.

The agency’s concerns follow a controversial report on Monday by US hedge fund Gotham Partners that questioned the risk concentrations held in monoline reinsurer MBIA’s credit derivatives portfolio. Gotham said if MBIA marked-to-market its collateralised debt obligation (CDO) portfolio it would have to write down a loss of $5.5 billion to $7.7 billion, an allegation vigorously denied by MBIA.

At the start of this year, UK Financial Services Authority chairman, Howard Davies, said one investment banker had recently described synthetic CDOs as ‘the most toxic element of the financial markets today’.

But Fitch added that the growth of the credit derivatives market generally should prove beneficial for the global financial system, as credit derivatives have enhanced the ability to transfer risk throughout the market. Federal Reserve chairman Alan Greenspan has consistently defended the role of derivatives as a risk transfer mechanism.

Related link: MBIA and S&P join war of words with Gotham over reinsurer’s AAA rating