Fitch Ratings today announced the launch of Derivative Fitch, the first specialist rating agency designed to provide the credit derivatives market with ratings, research, analytics and evaluation services that address the unique risks of the market.
With the credit derivatives market now approaching $33 trillion in notional value outstanding, the market has become a dynamic element of the global financial economy, as many participants utilize credit derivatives to manage their risk profiles. Unlike the traditional bond market, the structural complexity of the credit derivatives market is quite different as these instruments and securities are affected not only by risk associated with underlying assets but also heightened sensitivities to factors like credit stability and market risk. While hedge funds have been active participants in this market, traditional institutional investors, including pension funds, banks, insurance companies and fund managers, are increasing their participation in this market.
Moreover, while the role, use and performance of credit ratings are well defined in the traditional bond markets, credit derivatives investors and members of the global regulatory community have raised questions about whether traditional ratings alone completely address the risks inherent in the credit derivatives market. According to a recent paper published by the Bank of International Settlements on credit derivatives, “the one-dimensional nature of credit ratings based on expected loss or probability of default is not an adequate metric to fully gauge the riskiness of these instruments.”
The International Monetary Fund also recently published a paper mirroring the BIS’s sentiments. “Investors have shown a general preference for increased structural complexity and leverage, rather than greater credit risk. Going forward, rather than using more leverage, further innovations are expected to combine credit risk with other types of risk… The rating agencies should adopt a more differentiated rating scale for structured credit products.”
According to Fitch Ratings ceo, Stephen Joynt, “credit rating agencies have long played a vital role in helping give investors an informed and valuable third party perspective on credit risk. We’ve been very successful in the bond markets and today we continue our task of delivering prospective third party ratings, research and evaluation services focused on addressing the specific and expanding needs of the derivatives market.”
Derivative Fitch Today
Over the past several years, Fitch has invested in and furthered its expertise in the credit derivatives market. In forming Derivative Fitch, the company will consolidate over 100 professionals from its global Collateralized Debt Obligation (CDO) and Structured Credit ratings groups and related complimentary products, analytics and modeling groups to exclusively focus on this market. Fitch’s continuing dialogue with market participants and its ongoing research have
revealed that the knowledge requirements that investors need to actively participate in this market are different and broader that those needed in the bond markets. Sound investing requires an integrated perspective on credit and market risk, pricing and liquidity. While the single name swap and index markets are now quite liquid, the newest and most complex product markets are different; private, customized, illiquid and opaque. As with any market, investors with comprehensive understanding of these markets and instruments can make better decisions. The central goal of Derivative Fitch’s ratings, products and services is to offer such an improved perspective for investors.
In addition to ratings, some of the products and services that will operate under the Derivative Fitch name include:
- Vector 3.0, a benchmark model for assigning ratings to derivative products.
- Stability Scores, a new service for synthetic CDOs that references corporate portfolios and provides insight into the prospective stability of credit ratings
- Risk Analytics Platform for Credit Derivatives (RAP CD), a market risk assessment service for synthetic CDOs; Fitch also recently acquired the credit derivatives pricing and risk analytics models from Reoch Credit Ltd and announced a partnership with Markit Partners to incorporate their suite of credit derivatives data and tools into RAP CD.
- Valuspread, a derivatives pricing service enabling market participants to meet their internal and external regulatory requirements and assists investors in accurately assessing and pricing credit risk.
- FitchCDx, an internet based research platform.
“Fitch Ratings has consistently shown both leadership and innovation in its ratings, research and tools to help issuers and investors understand and adapt to an evolving market environment. Creating a stand alone company devoted to the derivatives sector demonstrates our commitment to the important needs of this market and will encourage the innovation and independent thinking needed to address them going forward,” Joynt added.