Synthetic Derivatives

Despite the damage attributed to them during the 2008 credit market crisis, synthetic collateralized debt obligations are once again in high demand among investors. The popularity of these risky investments, with their high returns and rock-bottom interest rates, are so high that even after being denounced by investors and a lot of lawmakers back in the day, now Morgan Stanley (MS) and JPMorgan Chase (JPM ) in London are among those seeking to package these instruments.

CDOs allow investors to bet on a basket of companies’ credit worthiness. While the basic version of these instruments pool bonds and give investors an opportunity to put their money in a portion of that pool, synthetic CDOs pool the insurance-like derivatives contracts on the bonds. These latest synthetic CDOs, like their counterparts that existed during the crisis, are cut up into varying levels of returns and risks, with investors wanting the highest returns likely buying portion with the greatest risk.

Granted, synthetic CDOs do somewhat spread the risk. Yet, also can increase the financial harm significantly if companies don’t make their debt payments.

A ruling by the Australian Federal Court against Standard & Poor’s could give 13 NSW councils about A$30M in compensation for their about A$16M in synthetic derivative losses. According to the court, the ratings firm misled investors by giving its highest ratings to complex investment instruments that ended up failing during the worldwide economic crisis. The councils can now claim compensation from S & P and co-defendants Royal Bank of Scotland (RBS)- owned ABN Amro Bank and the Local Government Financial Services, Ltd. The three had sold the councils constant proportion debt obligation notes, promoted as Rembrandt notes, six years ago.

Specifically to this case, Australian Federal Court Justice Jayne Jagot said that Standard & Poor’s took part in conduct that was “deceptive” when it gave AAA ratings to constant proportion debt obligations that were created by ABN Amro Bank NV. The Australian townships were among those that invested what amounted to trillions of dollars in the CPDOs, as well as in collateralized debt obligations.

The projected A$30M in compensation includes not just councils’ losses, but also interest and costs. The councils are also entitled to receive compensation for breach of fiduciary duty from LGFS, which succeeded in its own claim against Standard and Poor’s and ABN Amro for Rembrandt notes that it sold to its parent company after the notes were downgraded from their triple-A rating to triple-B+.

Articles Posted in Synthetic Derivatives

Synthetic CDOs Once Are Once Again In Demand Among Investors

Standard & Poor’s Misled Investors By Giving Synthetic Derivatives Its Highest Ratings, Rules Australian Federal Court