Profile: Lou Eccleston

The executive managing director of Fixed Income Risk Management Services, a new venture by Standard & Poor’s, tells Alexander Campbell why institutions need to improve their understanding of price movements to seize market opportunities.

With mark-to-market accounting firmly established, despite the havoc it caused to institutional balance sheets during the crisis, the financial industry needs reliable analysis not only of the credit quality of portfolios, but also of likely price movements. This, at least, is the thinking behind Lou Eccleston’s latest venture, Fixed Income Risk Management Services (Firms), a business owned by Standard & Poor’s but run separately from its troubled credit rating business.

Assessments of credit risk, even if they were accurate, missed an important part of the picture, asserts Eccleston, executive managing director of the firm.

“When you talk to a lot of investors, the biggest problem they’ve had is what has happened to the price of those instruments whether they decided to carry them to maturity or not, they had to mark them to market. So the assessments didn’t give enough insight and guidance about where the price of those securities might go, right across the board,” he says.

And although the crisis didn’t represent a systemic failure of pricing models, he argues, risk in the future direction of prices was underestimated. “You’ve had parts of the market that have not borne out the original analysis that was done.”

The plan is to use credit default swap (CDS) prices, and a swathe of other information, including capital structure, price history and volatility data, to derive a credit risk/return measure, allowing investors to compare fixed income products directly in more depth than would be possible using only credit ratings. One application, he suggests, would be to use the results to look for bonds that are underpriced relative to similar instruments with the same credit and market risk profile. But, he warns, this method will only provide short-term opportunities, especially as credit rating agencies themselves are planning to bring CDS pricing data into their own ratings, reducing the divergence between market opinion and rating information.

Unrated data

Another use would be to provide better analysis of the universe of unrated bonds. “There’s an enormous universe out there of companies that are not rated. We’re not going to say ‘here’s an unrated company in a developing market you should invest in’ – that’s not our job. Our job is to highlight areas where there may be an opportunity for an investor to then go and do more homework,” he says.

“You can think of it as a giant heat map for rated and unrated companies where there may be an opportunity to dive deeper, given there’s an attractive relative risk profile,” he adds.

There is often little information available on securities issued by non-public entities, which could pose substantial counterparty risk. This makes detailed analysis of revenues, operational health and liquidity important, Eccleston points out. Better analysis could also help reduce investor caution towards the unrated sector. “There are hundreds of thousands of companies that aspire to be of the size and capital structure to have a rating. I think if you can help these companies get noticed and grow, it will actually increase demand for ratings,” he says.