Credit has never been as spoken about as it is now and this not only applies to indexing as the trend is materialising in other segments of the market such as mutual funds, exchange-traded funds (ETFs), credit derivatives and structured products, said Thibault Aronio de Romblay (pictured), executive director, structured credit trading at JP Morgan, during the presentation Credit - The Adoption of an Asset Class, at the 3rd Nordic Structured Products and Derivatives Conference 2017, held on September 27th in the Grand Hotel, in Stockholm.

According to De Romblay, the iTraxx family which follows the performance of most liquid credit indices in Europe on a six-month rolling basis recorded recently USD$200bn of notional traded on a single day, a clear indication of the increased trading involving credit. In the meantime, the structured products market which has traditionally been dominated by equities (70% of the market) has recorded recently a shift towards fixed income products with US$80bn worth of structured notes linked to credit, including all the asset classes within credit.

"In 2015 and 2016 volumes in credit products were down since there was more regulation towards credit when for example the German regulator was looking at them but the outcome was positive and credit is distributed in Germany now," said De Romblay. "The trend towards credit has been renewed and there is strong appetite for credit linked products."

Overall, according to De Romblay, there is still more potential for growth in Europe for ETFs, mutual funds and structured products and clear growth prospects within fixed income and credit. De Romblay also noted that as a broad overview, structured credit products can be classified into two categories which "are two really different ways of doing the products".

"The first category is default based products which means that they are linked to the default in the underlying," said De Romblay, adding that investors will receive a premium and if there is no default in the underlying during the investment time, they get the principal back at maturity. "The default is quite transparent when determination committee that determines if the default has occurred under particular name based on public information."

According to De Romblay, in that category of products we find some of the most simple vanilla credit default notes "which are in a sense very similar to bonds except they offer greater level of customisation, the currency, maturity and the coupon type can be tailored". The customisation aspect is the main reason why these products are offered as they provide sometimes the only alternative to cash bonds, according to De Romblay. "Obviously these type of products have referencing single name and especially in Nordics crossover have been used extensively," said De Romblay."We can also use these products to effectively implement bullish and bearish views, [as well as] trigger payment if default happens, protect downside and hedge your existing investments."

The second category is price based products which are linked to the market price of credit assets, according to De Romblay. "These products are much closer to equity," he said. "The exposure is to certain market parameters, for instance if you could reference particular exchange rate fund or ETF that moves in value," said De Romblay. "And you could use that index to design products that give you exposure to that particular index (fixing of index on a particular date, link that product to the value that index has in a years' time, call on the upside of the index or sell downside risk, add more leverage). "We haven't yet reached the level of sophistication we see in the equity segment. With more market transparency and more information from providers such as Markit, we can get to the point where we can actually reference the level of the spread of a particular name for a product that is linked to this market."

De Romblay said that there are different variations of credit payoffs in the structured products market including vanilla index CLNs. "The most popular group is single name CLN's which are referencing to one particular name for example to the national champions like in Nordics to Swedish names and these are very favoured investment products," said De Romblay. "Also Quanto CLNs which are denominated into the local currency like SEK are very popular in the Nordics but these kind of products are not standard."

From an underlying perspective, the most popular underlyings used in credit-linked structured products globally are mostly from Korea and Germany and includes names such as Korea Land & Housing Corporation and Daimler, according to De Romblay.

As a dealer, JP Morgan trades two types of contracts including unfunded/swaps and funded notes, according to De Romblay. "Around 25% of the credit product market are in special purpose vehicles (SPV) which offer greater level of flexibility and remove issuer risk," said De Romblay.

According to De Romblay, most of the business in credit-linked products is recorded is Asia and emerging markets (EM) while quanto CLN's denominated in local currency dominate in the Nordic region, followed by leveraged notes, and zero recovery tranches are also used in Switzerland.

There are three main reasons to invest in credit structured products, said De Romblay. "Firstly, to get access to instruments that are difficult to access such as CDS," said De Romblay. "The second reason is the level of customisation that these products offer to investors."

There are some gaps in the corporate bonds market where some issuers haven't been active for a while, and some bonds available in the market do not match the interest of what kind of tenor you want to have, according to De Romblay. "Credit linked notes are an efficient way to bridge the gap and they are a way to invest in products that have the right maturity profile or the right currency," said De Romblay.

The third main reason to invest in credit-linked products is mainly "pricing and yield" as potential returns can be higher than some of the products out there. "Not just only because of the extra issuer risk but also because in some instances the credit default swap market implies higher level of spreads than the corporate cash bond market," said De Romblay, adding that the main challenges around credit-linked products include new regulatory requirements as around the Fundamental Review of the Trading Book (FRTB), Mifid 2, Priiips Kids and the US Securities & Exchange Commission (SEC) registration ban. "However, good opportunities are also increasing around transparency, technology and investible indices around credit and ESG."

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