Moody's Investors Service has developed a new framework to lay out the costs and actions involved in case hedge counterparties to cash deals are downgraded. Starting Sept. 1, all new cash deals double-A minus or higher that are rated by Moody's will have to follow the framework.

Moody's created the framework because up until now the costs and actions to be taken by a downgraded counterparty differed across sectors and locations, said William Harrington, senior credit officer. "In most cash-flow transactions that require a hedge, the hedge itself is modeled as if there is zero risk of non-performance by the counterparty. That's a big assumption to make," he said.

Hedges in cash transactions are often used for currency risk and mismatches between fixed assets and floating liabilities. Before the new framework, decisions as to how much collateral counterparties would have to provide in case of a downgrade, or if a counterparty had to be replaced, were decided at the time of downgrade. Laying out consistent plans ensures hedge counterparties can assess the cost of providing the hedge across sectors and geographies, Harrington said.

While Moody's used swap market conventions where possible, the agency had to adapt some of the standards for cash transactions. "Many market practices in derivatives work around the mark-to-market world, but cash-flow transactions don't act in a mark-to-market world," Harrington said.

Officials at Fitch Ratings and Standard & Poor's did not return calls by press time.

Samantha Rowan
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Securitization News
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