Monday, January 27, 2014

Credit Hedging Agency vs. Credit Default Swaps
This article appeared in The Edge, Malaysia on Nov 25, 2013

Some time back in September 2013, this newspaper published a convincing case of a Credit Hedging Agency model as an alternative to Credit Default Swaps to hedge credit risk in the Malaysian credit market. This initiative would allow investors to hedge the default risk in lower rated corporate bonds and hence promote the credit market segment. In this article, I examine the Credit Hedging Agency model and discuss its suitability as an alternative to the well-established credit default swap product.

Credit Hedging Agency: The potential business model

The establishment of Danajamin, a Financial Guarantee Insurer was to promote the issuing of lower
rated bonds, typically by small & medium enterprises (SME). The insurer guarantees payments to investors in the event of default of the bond issuer. The guarantee enhances the credit rating of the bonds to typically an investment grade type, and attracts investors to subscribe for the bonds.
However the above scheme does not tackle the issue of the general lack of appetite in lower rated bonds in the Malaysian credit market. Now with a Credit Hedging Agency in place, investors who otherwise would be wary of the default risk in lower rated bonds could potentially pay a premium to the Agency as a protection against default risk. Should there be a default, the investor delivers the