What is the history and background of your company?
Channel Capital Advisors LLP (CCA) is a UK based investment manager focusing on credit risk and structured finance transactions. CCA was established in 2006 by its founders and a consortium of European commercial banks. In 2007, CCA launched Channel Capital PLC (CC PLC), an Irish based operating company. CC PLC raised capital by issuing long dated junior and senior rated notes, and secured counterparty ratings from S&P and Moody’s. Despite difficult market conditions from mid 2007 onwards, CC PLC was successful in originating and managing over USD 10 billion of portfolio credit transactions and has generated attractive returns for its investors. More recently, CCA has been exploring opportunities in the regulatory capital space as well as loan portfolio intermediation and structuring term liquidity transactions.
Over the course of the past 12 months what do you consider to be the most significant development in the credit markets?
Markets have become increasingly concerned with the health of peripheral European government finances and governments’ progress in this regard. Lack of market confidence has led to higher interest on government bonds, which has made the task of reducing the debt/GDP ratio amid sluggish economic growth more difficult. ECB’s response has been to provide increasing amounts of liquidity in the market.
Given the banking sectors reliance on governments since 2008 and the extent of the government bond holdings by the banks, an unstable negative feedback loop has developed that needs to be dealt with.
Long term solutions would require a combination of deleveraging the economy, debt writedowns, austerity measures and painful structural reforms to stimulate growth and reduce fiscal deficits. These solutions take time and would require political will and public support neither of which is guaranteed.
"Operational and business risks of starting a new fund or running an existing fund below a sizeable threshold will increase"
What key challenges and/or opportunities does the current environment bring to your business and how do you intend to manage them?
Banking sector will have to deleverage to comply with the new capital requirements.This would be done through sale on non-core businesses, asset roll offs, asset sales, raising additional capital or risk transfer to other parts of the financial system.
CCA can offer solutions to efficiently transfer credit and or liquidity risk from bank balance sheets to investors. Long term investors can benefit from the increasing demand for capital to earn equity type returns by assuming credit risk of good quality portfolios.
CCA has also been active in intermediating loan portfolios between banks and end investors and has also provided long term funding solutions. We expect to be able to do more of these types of transactions as the underlying rationale from the banks’ perspective will persist.
What is your reaction to the changing regulatory landscape. How will it impact the buy-side?
Cost of implementing the regulations will put pressure on buy side profit margins especially for the small to medium size funds. Operational and business risks of starting a new fund or running an existing fund below a sizeable threshold will increase. This will allow larger investment managers with better economies of scale to capture a larger market share of assets under management. Some of the costs of the new regulations will most likely be passed on to the investors, putting further pressure on investment returns in an already difficult and uncertain environment.
"Cost of implementing the regulations will put pressure on buy-side profit margins specially for the small to medium size funds."
Do you see a world where investors should seek safety, or a world where investors should look to take on risk to capitalize on significant medium / long-term opportunity?
The choice ultimately depends on each individual’s risk profile, objectives and financial position. The environment is unusual in that persuasive arguments in favour of diagonally opposite outcomes can be made. References to bi-modal distributions are becoming more common. For example, there is not much of a consensus whether we will have very high or very low inflation in the coming years. Similarly, it can be argued that bonds are expensive but they could also conceivably stay at current low yield for an extended period as it is the case with Japan. Similar points can be made for commodities, equities, real estate etc. The collective impact of fiscal and monetary policy, protracted deleveraging in the economy, new regulations across various jurisdictions, political considerations in Europe and the possibility of Euro break up is highly unpredictable.
This has led to a risk on / risk off investment environment where short term tactical positions are taken by investors without much of a long term conviction. Given the prevailing uncertainty, this tactical approach with close monitoring of risk is prudent and I expect that it will continue for a while longer. However, the valuations are cheap in some markets, at least relative to historical measures. Investors with longer horizons and appetite for some volatility might be able to take advantage of these opportunities.
Looking ahead, what market development do you anticipate?
I think the deleveraging of the financial sector, government and households balance sheets will continue. Governments will try to, at least partially, inflate their way out of the debt load. The Eurozone will continue to experience stress. Default of one or more countries is widely expected. I would not rule out the case where one or more peripheral countries, faced with unpopular austerity measures, try to exit Euro.
Finally, I am going to go on a limb and think it possible that some basic, unleveraged forms of credit products, such as simple tranched corporate portfolios, will make a comeback in a few years time once central clearing platforms are more developed, the risk management infra-structure of the banks and investors are more sophisticated and banks start switching from survival mode to business expansion mode. These products could serve an economic purpose if properly integrated in a truly diversified portfolio. A parallel could be drawn with interest rate derivatives in mid 1990s when after some market disruptions and well publicised end user losses, the products made a strong comeback albeit with some never to be seen again casualties such as Libor squared and cubed based products.
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