The Trade Lifecycle: Behind the Scenes of the Trading Process

26

Credit Derivatives and the Crisis of 2007

Robert Reoch, Founding Partner, Reoch Credit Partners LLP

 

 

The following chapter discusses many types of risk and explains how a recent and well-known financial crisis was linked to issues connected to the trade lifecycle.

26.1 BACKGROUND

26.1.1 SIVs

The use of Conduit Financing Vehicles (“CFVs”) or Structured Investment Vehicles (“SIVs”) was extensive and was established in the late 1980s. The structures disintermediate banks by enabling a range of long dated debt instruments to be financed by short-term debt. To the extent that short-term financing becomes unavailable, the structures use a back-stop facility provided by a bank. This secondary source of financing is designed to plug any financing gaps and generally will only be used when liquidity is in short supply. As a result of the back-stop, the ratings agencies are prepared to give the short-term debt a high credit rating.

An SIV¹³ is structured as an SPV that buys long dated assets such as debt instruments and finances the purchase by issuing short-term debt such as commercial paper. The debt instruments that the SIV buys can be corporate debt - bonds and loans, or retail debt - pools of mortgages, credit card receivables, car loans etc. The SIV normally enjoys a healthy profit due to the fact that short-term borrowing rates (what the SIV pays) are normally less that the return on the longer dated assets. SIVs can be very profitable because they are highly leveraged and ...