Uncertainties Inherent In Synthetic CDOs / Credit Default Swaps

As instances of default under collateralized debt obligations (CDOs) rise, uncertainty over the resolution of eventual disputes takes on increasing significance for parties to derivatives investments. Nowhere is this better demonstrated than in the enforcement of rights under credit default swaps. By 2008, outstanding credit default swap contracts had a combined market value of more than US$2 trillion¹.

Synthetic vs Cash CDOs

CDOs are a form of asset-backed security under which a special-purpose vehicle (SPV) is established to hold cash-producing assets carrying various levels of risk and reward. The SPV issues bonds or other securities to investors in tranches which reflect the productivity of the assets from which their value is ultimately derived. Often the SPV is an offshore corporation established to avoid or minimize tax otherwise payable to the revenue authorities of the U.S., Canada and other industrialized countries.