Jeffrey Kushner, ceo of BlueMountain Capital Partners (London), answers SCI's questions

Q: How and when did BlueMountain Capital Management become involved in the fundamental credit/derivatives markets?
A: Since inception in 2003, BlueMountain Capital Management has been a relative value, multi-strategy credit manager with a unique expertise in credit derivative products, markets and structres. We are active in many types of credit products, from cash bonds and loans, to structured products including ABS, to the full range of credit derivatives contracts. This gives us a unique perspective on what is going on in the credit space.

Q: What is BlueMountain's history in London?
A: We began as a North American-focused business. As head of trading, I took a lead role in launching our European business in mid-2004.

We set up the London office in 2005 and have maintained a presence here ever since. I relocated here in August of 2008 from our New York headquarters and anticipate remaining in the UK long-term.

Europe is an essential part of our strategy. Some view Europe as the second largest credit market, but it actually is approximately 10 individual markets.

These markets present many challenges and successful investors need to understand the differences among the 'sub-markets'. These differences include investor bases, national banking champions and, most importantly, legal framework as it applies to creditors.

Over our five years of trading these markets, we have developed a powerful understanding of how to be successful and which situations are best avoided. It is important to respect the differences in the region from the US. For example, liquidity is not the same in Europe as it is in North America.

My role in London is multi-faceted. I am responsible for dealer relations and investor interaction, and serve as the senior BlueMountain representative in the region.

Q: What are your key areas of focus today?
A: One key advantage of running a multi-strategy credit fund is that we get to allocate capital and other firm resources to the best opportunities in the credit space as they arise and in a coordinated way. Over the past 18 months we have seen the opportunity to morph significantly from an arbitrage opportunity, where managers attempted to make money by not necessarily taking too much credit risk (ex basis), to an environment in which credit is king.

The dislocation and subsequent rally have created stark choices, in which there is a fertile environment to choose obligors whose debt is cheap in relation to risk and vice versa. Fundamental long/short alpha has been our biggest driver of returns for the past 24 months and we anticipate that continuing for some time to come.

Q: What has been 2009's most transformative change in the credit market?
A: The speed of the recovery has surprised me somewhat. In March some thought that the world was going to end.

We had professionals examining scenarios as dire as 35% defaults and 450 on the S&P. It doesn't look like either of those will happen.

The recovery in technicals has been extremely strong. It will take some time to see if the fundamentals match.

As a result, the truth is that not much has changed from 2006 or 2007. With each passing day we are seeing the return of leverage, bank prop desk activity and even whispers of the return of structured products.

At BlueMountain we are being very vigilant in watching this, as we are not quite as convinced about a robust recovery. Rather, we just see the wall of money, which can come down at any time.

As I reflect, I think that the reduction in gross notional and the continued move to central clearing in credit derivatives is likely to be the most transformative change of 2009 in credit markets. Once complete, this will address many of the issues surrounding the space, including counterparty risk and transparency, and will likely result in more broad-based participation.

Q: How has this affected your business?
A: We have materially upgraded our fundamental credit research team, including the addition of four staff members that have distressed experience. The team now totals 17 people.

This goes hand-in-hand with changes in the portfolio management team led by Derek Smith, who joined in early 2008. Derek has transformed our fundamental credit business. We are now much more focused on a smaller universe of names, where we have high conviction and in which our investing team can create and maintain some kind of competitive advantage.

While much of the 'low hanging fruit' is gone, there is still a surplus of good opportunities in bank capital, legacy structured product and stressed names. The key for us is that we have been able to retain our competitive advantage in technology, market intelligence, product knowledge and operations, while significantly upgrading our research. Thankfully, we have been able to add strength during the crisis.

Q: What major developments do you expect from the market in the future?
A: These developments broadly fall into two categories, one of which is germane to Europe.

There is a move to significantly more standardisation in the credit derivative space. All of this is in response to the events of 2008, Lehman, AIG, etc. There will be standard contracts on most credit derivative products, including single name, index and index correlation products.

This standardisation has reduced the uncertainty around events via a dedicated committee (the Determinations Committee) that opines on all corporate events while increasing the fungibility of contracts through standardised coupons. All of this is a precursor for a centralised clearing mechanism.

This is largely in response to what was viewed as the twin problems of larger gross notionals and counterparty exposure. The central clearinghouse solution, which is being encouraged by large market participants as well as regulators, will allow netting of positions and protect participants from direct counterparty exposure. Both of these factors should enhance market stability and therefore encourage new participants.

There has been quite a bit of discussion in Europe around the "wall of debt" that is ahead of us. Approximately €130bn of high yield loans mature between 2012 and 2014. What will happen to "roll" this debt?

A large portion of the debt is held by CLOs and uncertainty exists around their future viability and, therefore, their ability to continue to lend. Much of the remainder is held by banks and is not marked to market.

Many hope that the leveraged finance market in Europe will develop to look more like the US market. The US leveraged finance market is largely a public market with bonds predominating. Additionally, in most cases the bonds are widely distributed to investment professionals of different types rather than being held by CLOs and banks.

In order to strengthen the European debt market, the correct incentives will need to be put in place by the market and the regulators to help to change long-term behaviour.