eBond Advisors co-founder and managing partner Richard MacWilliams and ceo Bryan Jennings answer SCI's questions

Q: How and when did eBond Advisors become involved in the derivatives markets?
RM: Mac McQuown and I founded eBond Advisors in 2010, with the goal to explore improvements in the structure of corporate bonds so they could be purchased by more investors. This effort was a direct outgrowth of the credit crisis where corporate bonds were unnecessarily affected by market structure problems that had little to do with corporate creditworthiness. The upshot was the creation of eBonds, short for exchangeable bonds, which embed a cleared CDS into a corporate bond to produce a hybrid security (SCI 17 March).

Since its founding, the company has benefited from investment and participation by leaders in banking, financial engineering and money management. It also enjoys important ties with leading investment banks that recognise the need to evolve the corporate debt markets to accommodate the current and future needs of issuers and investors.

Q: What are your key areas of focus today?
BJ: Dozens of articles have been appearing now for months detailing the risks that have developed in the corporate bond markets. A recent report by the Bank for International Settlements raised some fundamental issues, such as falling trading volumes and substantial declines in the dealer positions in corporate bonds. Most experts attribute this decline to a significant drop in the willingness of dealers to hold positions in corporate bonds, resulting from new capital requirements and the consequential decline in secondary market liquidity.

In addition, US corporate bond issuance has nearly doubled since the financial crisis, with much of the marginal new supply being purchased by fixed income mutual funds and ETFs. These asset managers have also steadily increased their degree of market concentration as well. What we are seeing is market liquidity increasingly dictated by the portfolio allocation decisions of a few large asset management institutions.

RM: Finding liquid positions is proving to be far more difficult than expected for such institutions, especially during an adverse shift in market sentiment. The result is that the cost of debt capital is going up. In the past six months alone, corporate borrowing costs have risen by 25bp to 75bp in relation to CDS pricing to accommodate the lack of liquidity.

This is particularly telling since CDS trading volumes are experiencing meaningful growth again, while bond trading volumes struggle to keep pace with issuance volumes. In fact, more risk is being traded in single-name corporate CDS than in the cash bond market on an annual basis.

We are clearly now at a point where liquidity is declining in the corporate bond market and improving in the CDS market, but issuers need a mechanism to access the incremental liquidity made available by the CDS market. eBonds allow issuers to access the pools of capital being transacted in the synthetic credit markets.

Q: How do you differentiate yourself from your competitors?
RM: While other market participants have focused on adjusting trading practices, eBond Advisors has focused on making improvements to the structure of corporate bonds themselves; specifically, providing the means for investors to manage credit risk independently of duration/funding risk within the actual bond. Embedding cleared CDS directly into a corporate bond structure gives investors this credit risk management flexibility.

BJ: eBonds provide more alternatives for investors and issuers. Investors will enjoy single security accounting treatment, with no bifurcation of the bond and CDS contract. eBonds - if enhanced with CDS protection - will provide favourable risk weighting treatment for regulated financial institutions and favourable financing treatment, since the CDS is perfected within the pledged security.

For investors, the ability to choose, price and purchase independent risks improves immeasurably. Issuers of eBonds will also have the option of accessing wider capital pools, since bond investors will be competing with CDS credit investors. This should serve to limit or eliminate needless liquidity premiums for borrowers. Two markets, both pricing credit risk, will finally compete for the same risks in the market.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
BJ: We have already accumulated significant weight with investors and Wall Street firms. Among our investors and partners are several business leaders, such as John Reed, chairman of MIT Corporation and former chairman of the NYSE, and former Barclays Global Investors ceo Blake Grossman.

We have discussed eBonds with close to 50 companies at this stage. Thus far, we are tapping into a market that many players have distanced from in recent years, mainly due to the bad reputation that the derivatives market gained following the crisis. Because of their caution, we've had to educate many clients on how the product can save them meaningful amounts of money.

Q: What major developments do you need/expect from the market in the future?
RM: We expect to see eBond transactions coming through relatively soon. Additionally, although eBonds are largely US-centric for now, we would like to eventually branch into Europe.

The reason this has not yet happened is due to compliance barriers with some ISDA terminology. The differing standards were creating a mismatch between the bond terms and CDS terms, but these have recently been updated and now provide us with the avenue to begin shifting our attention in due time. We will likely use the same underwriters that we have used in the US, but there will be some scope to approaching the main European banks too.

JA