“Spreads on Japanese credits are so tight at the moment, so investors need to either look at foreign credits or look at the lower tranches with less subordination,” says Jun Shibata, senior structurer in the credit trading and derivatives department at BNP Paribas in Tokyo. “And if they look at the first-loss piece or lower CDO tranches, the investor would want to have some substitution rights, because they don’t know what may happen to the portfolio in, say, two years’ time.”
The transaction has several guidelines in place to restrict the substitutions the investor can make. For instance, any replacement credit must be of a similar rating to the one that has been removed, while the investor cannot substitute more than 10% of the portfolio each year.
However, to help investors manage their transactions, BNP has developed an internet-based system called TradeAssist, which allows customers to simulate the impact of any substitution trade on the portfolio. Launched at the end of last year, the system calculates the impact on the coupon of any trade – although investors cannot perform live trades through the TradeAssist.
“This is a relatively new tool and allows the investor to simulate the substitution to see how much the coupon will increase or decrease after substitution,” says Shibata. “But it’s just a simulation tool and the final trade will be done through direct contact.”