“The likes of AIG should never have had the ability to sell protection on CDSs without the posting of collateral, that was insane,” Kobayashi said. CDS acquired a risky reputation for a lack of transparency in the wake of AIG’s sudden, largely unanticipated collapse, and Kobayashi admitted she was now explaining the asset class as much, if not more than, she explains and promotes her own CDS fund. However, she said the scrutiny of CDS has had an upside: it had “sped along” the formation of the CDS market’s first clearing house for the buy and sell-side. “A central counterparty will help show people these assets are not inherently toxic,” Kobayashi said, by moving the market away from over-the-counter status to one in which valuations and contracts are standardised, the size and price of trades must be reported, and counterparty risk (a la Lehman Brothers) is minimised.
At presstime, the US-based IntercontinentalExchange was leading the race to become the default clearing house, with single-company CDSs due to be tradeable through it in this quarter. Mellon CM’s Credit Market Neutral Fund lives up to its name by being US dollar neutral and neutral on shifts in spreads beyond 10 per cent (ie where a CDS on a spread of 50 bps moves more than 5 bps in either direction). Kobayashi said the fund typically holds between 85 to 95 of the roughly 340 US names on issue. It’s big money-maker in 2008 was short positions in US home builders. It became a seller of protection in the builders in early 2007, when their average spread was around 40 bps, which subsequently blew out to multiples of that.