A ratings agency has launched a review of a controversial form of credit insurance described as "a riddle wrapped up in a mystery".
Fitch Ratings said it was concerned that the tradable derivatives ...
A ratings agency has launched a review of a controversial form of credit insurance described as "a riddle wrapped up in a mystery".
Fitch Ratings said it was concerned that the tradable derivatives, called self-referenced credit linked notes (CLNs), concentrated risk in the issuer.
Fitch started asking questions about self-referenced CLNs when it emerged that Parmalat, the failed Italian milk group, had invested £21.5m in self-referenced CLNs issued by Sires-Star #121, a special purpose vehicle set up by Merrill Lynch International in the Cayman Islands.
Fitch reported: "The primary concern is that these investments may be rated at the level of the company at the time of issuance, but the liquidity and credit profile is correlated 100% to the company's credit profile.
"As such, liquidity and capital resources are tied up in a financial asset that has diminishing value at exactly the wrong time - when the company is under financial stress."
It added that a "CLN investment may accelerate the financial decline rather than serving as a buffer."
The market for self-referenced CLNs is believed to be small but Fitch said "it could be argued that the risks outweigh any short-term benefits."
Fitch will survey companies and warned that any using self-referenced CLNs could see their credit ratings changed as a result.