search   Knowledge Bank printable version
 Knowledge Bank
 Deal Information
 Industry Events
 Advocacy Forums
 Site Utilities
 Free Offers

Click here to
Update Registration

Please be advised that the use of ®
is subject to the
Terms & Conditions

of use and the
Privacy Policy


Best viewed in

Knowledge Bank > Financial > General
Select an area

Special Extended free trial for site members.

CDOs vulnerable to private equity
Asset Securitization Report--SourceMedia (November 13, 2006)

Nora Colomer

Leveraged financing is fuelling a significant expansion of the European private equity market. But the increasing level of debt used to finance private equity deals could leave transactions exposed to certain weaknesses in the event of a workout, according to the Financial Services Authority (FSA), the U.K.'s financial watchdog.

Thirteen banks responded to a recent leveraged buyout (LBO) survey conducted by the FSA and reported a combined exposure to private equity of 67.9 billion ($86.8 billion) by June 2006, compared with 58 billion at June 2005. The survey found that banks are increasingly distributing debt to non-banks such as CLO managers, CDO managers and hedge funds. On average banks distribute 81% of their exposures to their largest transactions within 120 days of finalizing a deal.

The FSA is concerned that the duration and potential impact of a credit event may be exacerbated by operational issues, which make it difficult to identify who ultimately owns the economic risk associated with an LBO and how these owners might react in a crisis. These operational issues arise out of the extensive use of opaque, complex and time consuming risk transfer practices such as assignment and sub-participation, coupled with the increased use of credit derivatives.

In a workout situation, credit derivatives might take longer to be confirmed and the amount traded may substantially exceed the amount of the underlying assets. Traditionally, when a deal goes bust, it is put into a club to sort out the workout process. A highly levered deal may not favor the survival of distressed companies and could create confusion, which would ultimately damage the timeliness and effectiveness of workouts following credit events. Under an extreme scenario, a deal gone bad could undermine an otherwise viable restructuring. "The increased dispersion of the debt associated with private equity transactions diversifies risk but adds considerable complexity to the process of identifying economic risk exposures and managing workouts," explained David Cliff, a spokesman with the FSA.

But Cliff added that there have been relatively few defaults recently, due in large part to the fairly benign credit environment. "Where defaults have occurred they have not (so far) involved corporate bodies whose debt/credit risk was particularly heavily traded," he said. "We are highlighting this issue now, conscious that more defaults may occur (including with respect to heavily traded corporates) if interest rates continue to rise."

The FSA is also concerned that as deals get larger, to include a larger presence of leveraged financing - such growth could lead to abuses. The involvement of participants in both public and private markets and the development of related products traded in different markets, such as credit default swaps on leveraged loans, increase the potential for abuse. "As the deals get bigger it means more investors [are] in the circle of information," Cliff said, "there is a risk of abuse...that results from some of these buyers trading in related instruments."

As part of its solution the FSA has proposed a set of risk mitigating actions, which include increased surveillance of the credit markets, regularly surveying leveraged lending and distribution and gathering information from trade associations and experienced market practitioners to help understand the issues and risks inherent in dealing with corporate defaults. Cliff said that the FSA findings will be open for discussion over a four month period. "The idea is to get comments back from the market on whether our level of regulation is appropriate," he said. "We are encouraging other bodies to engage in private equity and build an understanding of it and we want to get it right."

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.



© Copyright 2014. The Mayer Brown Practices. All rights reserved.

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the “Mayer Brown Practices”). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. “Mayer Brown” and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

Legal Notices | Attorney Advertising | Site Index | Contact Webmaster

*The site links listed on this web site are for reference use only.
The firm does not necessarily sponsor, endorse or verify the accuracy of the content contained in any of these sites.