Over in Mac McQuown’s Sonoma Valley workshop, courtesy of Bloomberg Markets…
McQuown says his eBond will enable investors to jettison their credit risk because the swap, which is essentially a form of insurance, will cover their losses should the debtor fail. To garner such protection now, an investor must purchase a swap separately to cover a bond.“We’ve finally figured out a way to make a bond default-free,”says McQuown, a partner at eBond Advisors LLC, a New York-based firm that’s producing the new security.
OK. Here’s how an eBond — high-yield corporate debt embedded with a CDS, through the wonders of centralised clearing — works, according to Bloomberg:
We like the ‘legal language added’ line. It’s a good job bond-clause wording never blows up and investors always read the small print.
Or here’s how it works according to the patent filing, which also covers eMBS and eBond Funds (hat-tip Tracy Alloway):
You could say this is nutty. There is an element of credit-enhancement deja vu about the idea.
But let’s assume eBonds can make corporate debt more tradable, and that the cleared CDS market makes this possible.
At what cost? Well, diminished credit risk, as the man says.
Whereas here’s another nutty thought we have at the moment. Institutional investors would actually quite like some credit risk these days. It’s clear an insurer managing its assets by ploughing them into credit-riskless corporate bonds, let alone government debt, isn’t currently getting paid for it.
What do these investors do, when they aren’t very good at credit risk, or leveraging returns on it, or managing the illiquidity involved, though?
They might still go to the bond market. But also, for example, there’s what we’re starting to think of as the Yield Businesses Formerly Known as Private Equity.
Apollo (for instance) now owns a German bank, contains an embedded insurer with $60bn in assets, is ever more involved in direct lending to companies, and operates managed accounts alongside its usual funds for confused and lost credit investors. There are also the corporate credit empires being built at KKR and Blackstone/GSO, and elsewhere — all to let investors in on bits of corporate credit risk they can’t otherwise reach, for returns which seem reasonable versus alternatives in fixed income. And of course, all for a fee.
Versus eBonds and the like, maybe that’s where the real credit ‘innovation’ is happening…
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