Future trends in the structured credit market

Abstract

In recent years, credit markets have been characterised by the strong growth of credit derivatives and structured credit, not only in terms of the volume of derivatives traded, but also the number of underlying reference entities and the complexity of the payoffs involved. The subprime turmoil, however, might be the turning point for the structured credit market. While there are apparent consequences for the future of credit derivatives, in the long run the crisis will also highlight the more subtle deficiencies in the existing market structure. The obvious conclusions are: (1) in the medium term, investors will avoid complex structures, and (2) trade in plain-vanilla credit default swaps will increase, as these have been the only instruments to remain fairly liquid during the crisis and provide a hedging tool for investors. In addition, there is a structural change in the credit market which is largely independent of cyclical aspects. The trend towards imposing credit derivatives technology on other asset classes continues, with collateralised debt obligations on equity default swaps, commodity swaps and foreign exchange markets having already been established. In the long term, the so-called collateralised asset obligations regime is expected to replace old-fashioned risk-return optimisation.