The credit default swap market may be relatively unknown to many consumers and investors, but it’s one that is proving to be vital as the financial markets continue to evolve.
In simple terms, credit default swapping is a derivative contract that transfers the credit exposure of fixed income products and can involve bonds or securities.
Over the last several years, the market has been gaining traction as demand for cash alternatives and affordable and low-cost swap facilities have steadily increased. Notably, the credit default swapping market gained notoriety in the midst of the late 2000s financial crisis and, according to a report, is considered the third-largest over-the-counter derivatives market in the world valued at US$8 trillion as of June 2018.
As a result of the financial crisis, regulatory changes at the time were meant to address fragilities within the market and were then implemented at a global scale. These regulations have had a structural impact on the market but have also provided greater visibility.
That being said, challenges still exist within the credit default swapping market, including a prolonged decline in investment yields. At the same time, the credit default swap market has shrunk dramatically from over $50 trillion to roughly $5 trillion.
Headquartered out of Toronto, Ontario, DelphX — through its special purpose vehicle Quantem LLC — helps fixed income dealers offer new private placement securities that optimally transfer and diffuse credit risk while allowing the enhancement of yield.
In an interview with The Market Herald, DelphX CEO Patrick Wood said that the company was “built on the idea of bringing a new product to market where only one product existed” within the credit default swapping market.
“The bond market is the largest market in the world, with trillions and trillions of bonds issued, but there’s only one way for a bond investor to preserve their capital if a bond defaults, and that is through the use of a credit default swap,” he said.
While the company only went public in 2018, it is already making headway in tackling the unmet needs of a market vastly in need of a transformation through its first-of-its-kind product that enables transparent arbitrage of risk/price, provides counterparties with transparency and democratizes a hedge that was previously only available to a handful of investors.
Current issues in the credit default swap market
Wood told The Market Herald that the current way for investors to preserve their capital if a bond defaults first came to fruition in 1994 and was created by JP Morgan. At the time, banks would offload the risk of repayment for a fee, while the entity would hold the risks and receive regular payments.
Wood said that this method served its purpose at the time, but over two decades later the market is in vast need of a makeover.
Wood exemplified the financial crisis of 2007 and 2008 where companies like AIG Insurance were giving people insurance in the form of credit default swaps but didn’t have the collateral to cover the amount of insurance they were providing.
“In 2007 and 2008, credit default swaps became a terrible constraint because (insurance groups) … didn’t have the collateral to pay off those insurance policies,” he said. Wood said that governments were also stepping in and overregulating the market by making it difficult for the issuer of default swaps and the buyer of default swaps.
He said that essentially the market got crushed, diving from a $50 trillion market to a $5 trillion market by 2012.
“[DelphX] saw an opportunity to not only give investors another alternative to credit default swaps but also to take the idea of credit default swaps and insurance on bonds defaulting to a whole new level,” Wood said.
The DelphX credit default swap solution
Wood told The Market Herald that the interest in the market resulted in there only being one existing solution that was “clearly fallible” and needed something better.
“[DelphX] was looking to turn a stone-age product from 1994 into something that is more amenable to what people want in 2022 and beyond,” he said. “That is something that is more transparent, more dependable, safer and something that will be there when you need it and keeps manipulators out of the actual product itself.”
Through its special purpose vehicle Quantem LLC, DelphX helps fixed-income dealers offer new private placement securities that optimally transfer and diffuse credit risk while allowing the enhancement of yield.
“[DelphX] has developed a solution that won’t allow banks to interfere,” Wood said.
The new DelphX securities will enable dealers and their qualified institutional investors (QIBs) accounts to competitively structure, sell and make markets in:
- Collateralized put options (CPOs) that provide secured default protection for underlying corporate, municipal and sovereign securities.
- Collateralized reference notes (CRNs) enable credit investors to take on the default exposure of underlying security in exchange for enhanced yield.
Wood explained that DelphX has created “an ultimate default risk management tool,” which it has now launched after building it.
In early June, the company announced the first issuance of its proprietary CPOs and CRNs, which makes this the first institutional issue of this new class of structured products. The company said these transactions were done in connection with custodian BNY Mellon, LPS capital and two institutional investor accounts.
This marks a major milestone for DelphX for finalizing a multi-year development effort as well as initiating the commercialization phase of the product.
“We’re moving into a segment where we expect to displace a lot of the credit default swap market, but also bring back people to using bond insurance and default insurance in a fully collateralized way,” Wood told the Market Herald, adding that it is more transparent and completely dependable.
Now that the company has begun rolling out its product, it enables DelphX to pursue a full product rollout by leading bond dealers who have been eying these industry-first products. Thanks to the rollout initializing, DelphX anticipates receiving strong interest from financial institutions that can’t use CDS or other derivatives but can use DelphX’s CPO and CRN products.
“The timing is the other variable that is working very well for us where we can provide investors with the insurance, they need to protect their holdings, but also to be able to speculate and take positions against what they see as very, very weak issuers and bonds going forward,” Wood told The Market Herald, explaining that current challenges such as high inflation, stagnant economies, recessions and geopolitical tensions can impact default rates and bond pricing.
The leadership team
Patrick Wood, CEO
Patrick Wood is a successful capital markets veteran with a career spanning over 25 years in Canada and the United States. Wood’s career has included fixed income asset management, structured product creation, and advisory roles at Canadian-owned broker-dealer Midland Walwyn, vice president roles at both BMO Nesbitt Burns and CIBC World Markets and managing director role at Loewen Ondaatje McCutcheon. Recently, Wood founded Tormont Group, a US and Canada-based Advisory and Merchant Bank. Since 2012 Tormont Group has provided capital and supported US and Canadian companies on IPOs, M&A, institutional investor development, and successful market penetration strategy.
Simon Selkrig, CFO
Simon Selkrig has a strategic, results-focused & problem-solving mindset with 20 years of commercial experience helping companies to grow revenue, improve profits and increase valuation to stakeholders. His experience covers both corporate, both public/private and multinational/CCPC, entrepreneurial (via Strategize Financial Modeling and its clients) and board experience (ShareLife charity), to build relationships with all stakeholders, and drive better financial reporting and disclosure, corporate governance, internal controls around costs and employee engagement in companies.
Selkrig is also CPA Canada and CPA Australia chartered accountant, who has an accounting degree and an MBA in finance and international business, 20 years of financial experience in seven countries, including North America, Australia, UK and India and has worked in the Big 4, industries including, private equity/family office and corporate advisory/professional services
Gordon Jardin, chief actuary and risk officer
Gordon is a Fellow and past board member of the Society of Actuaries, a Fellow of the Canadian Institute of Actuaries and a member of the American Academy of Actuaries. He has been CEO and chief operating officer of reinsurance companies (Generali USA, PartnerRe Life/Winterthur Re), vice president and general manager of reinsurance for Sun Life Canada and, more recently, CEO of a residential mortgage acquisition and servicing company, Franklin Credit Management Corporation. Jardin’s extensive experience in developing and operating complex analytical systems is key to the development of the DelphX platform.
The investment opportunity
As of the time of this writing, DelphX has a market capitalization of C$19.51 million, share price of C$0.16, 121.95 million total shares and 122.97 million total shares.
With the credit default swapping market in need of a complete makeover and updated solutions, DelphX is the only company that is actively transforming the market.
DelphX also anticipates being fully operational by the second half of 2022 with its automated platform, which will be integral for the company in becoming an alternative trading system for structured products.
In short, DelphX will be a company investor want to get in on now in order to capitalize on a much-needed overhaul in an industry that isn’t going anywhere anytime soon.
FULL DISCLOSURE: This is a paid article produced by The Market Herald.