Frank Iacono, partner at Riverside Risk Advisors, answers SCI's questions

Q: How and when did Riverside Risk Advisors become involved in the structured finance markets?
A: Although we formally announced our launch recently (see SCI issue 204), we have been quietly doing this business for about a year. There are several significant engagements we are currently working on and some we have already completed for clients.

My own background is in structured credit. I was on the Street for ten years, starting in 1998 at Chase, where I structured mostly corporate synthetic CDOs. From 2001-2006, I was at Lehman Brothers and at different times ran the synthetic CDO structuring and trading desks in New York.

For a time, I was also responsible for the single-name credit-linked notes group. I dealt almost exclusively in corporate credit.

From 2006-2008, I was ceo of a subsidiary of Morgan Stanley called Cournot Financial Products, which sold protection of highly-rated corporate synthetic tranches. The company was sold by Morgan Stanley in 2008 (see SCI issue 116). Since then I have been doing some consulting and litigation advisory work and more recently focusing on building Riverside's business.

Q: What are your key areas of focus today?
A: Collectively between the partners and employees we bring expertise in fixed income derivatives and structured products. We are working with corporate clients to help them choose the best hedge and structure the deal the right way, including the documentation, to provide transparency as to the economics of the transaction and ultimately help them get best pricing and execution from their bank counterparties.

A big part of the economics is the credit valuation adjustment (CVA), which in the context of our business is the add-on charge that a bank charges its clients for taking on credit exposure in an uncollateralised derivative obligation. We have our own proprietary CVA models, which we are continually enhancing.

Measuring and managing CVA risk is a natural outgrowth of my credit correlation trading background and CVA is important to us for several reasons. First, for many of the transactions in which we act in an advisory capacity, CVA is the least transparent component of pricing for the end user. Second, we believe CVA is likely to be one of the next major traded risks.

Right now the Street is figuring out how to value, measure and manage counterparty risk. Some dealers have very advanced thinking on this and some do not. It is very much in the process of being understood and there is a wide range of methodologies and practices.

At the same time, you have Basel rules kicking in, which will increase the regulatory capital charges associated with counterparty performance risk on derivatives contracts. This is an area where our understanding of the risk helps us bring our end-user clients transparency as to what they should be paying on their hedging contracts.

We're focused on ultimately being able to trade counterparty risk, either for our own account or on behalf of our clients. Given our backgrounds and what we see working with our clients, we think we can make some big strides in this area.

We also provide advice to a broad range of clients other than the corporates. As an example, we are working with a global bank that has a legacy structured credit business in wind-down and we are helping by providing expertise in respect to counterparty and market risk, while also providing transaction ideas to help it achieve the wind-down most cost effectively and expeditiously.

We also work with hedge funds that see opportunities in structured credit, but do not have the infrastructure and skill-sets in-house to evaluate these opportunities. Essentially, we lend our expertise to people that are not going to be a big enough player in the space to need permanent full-time professionals, but who want to make the most out of specific opportunities by leveraging off our deep transactional experience across a broad platform of derivative and structured products.

We are also working with counterparties facing LBSF in the Lehman Brothers bankruptcy. Individual counterparties are negotiating with representatives of the estate to determine the close-out amounts of derivatives and structured note positions.

Riverside adds value by providing a substantiation of the value and negotiating directly with the estate on a client's behalf. The skills that are needed are more than just the ability to model the transaction, but also the ability to size appropriate bid/offers and justify model input parameters, like correlation, which are not directly observable.

Q: Which market constituent is your main client base?
A: We have no main client base. We've worked with corporates, project finance sponsors, private equity firms, banks, hedge funds, more traditional asset managers and high net-worth individuals. Our clients are any end-user, dealer or investor in derivatives or structured products who has either a limited need - such as a corporate treasurer doing three interest rate swaps a year to hedge its financing or terminate a swap - or who has a temporary need - such as a bank winding down a legacy book - or even on an ongoing basis, where there is a limited need and outsourcing expertise is the best option.

Q: Do you focus on a broad range of asset classes or only one?
A: We are sticking closely to our expertise. My background is structured credit and to some extent rates and options. Chris Frost has a background in interest rate and FX derivatives, while Joyce Frost - who has worked with me both at Chase and at Morgan Stanley - has a background in a combination of credit, rates and currency swaps.

That is our core, but we are eyeing opportunities in municipals or commodities, which we see as potential expansion areas for our business in the coming months. For those, we would look to bring in someone senior who has lived and breathed the business for a long time.

Q: How else do you differentiate yourself from your competitors?
A: Every member of our team has significant transaction experience on the Street and some of us have both Street and buy-side experience. We bring to our client mandates hands-on transaction experience that you cannot get from a text book or a classroom.

We have been there and done it successfully and that means clients get a very high level of expertise without making a permanent hiring commitment. You are really getting the A-team that you would get on the Street, but working solely for the best interests of the client.

Q: What major developments do you expect from the market in the future?
A: Dodd-Frank is going to create a regulatory regime for swap dealers and major swap participants requiring exchange trading of many derivatives and collateral and margining rules for most. We think the corporate end-users we work with are likely to be exempt from these requirements, but there will likely be an impact on disclosure and cost as capital charges for counterparty risk will increase.

There will be a continued need for our expertise, which is where the CVA element is relevant again. There will be a need to know what the appropriate CVA is for financial reporting purposes as the disclosure rules get enhanced.

A key factor with Dodd-Frank is the creation of a requirement that certain counterparties have independent advisors on their derivative transactions. These counterparties - which include municipals, pension funds and agencies of the federal government - will need our services.

Even where there is not a hard-and-fast rule created by legislation, we think independent advisory is going to become a best-practice standard. Just as M&A transactions see both buyers and sellers having an investment bank providing advice, we think that convention will come to derivatives transactions.

JL