One of the key CSO benefits is the two-way liquidity of the underlying corporate CDS, according to Guillaume Mear, head of structured credit trading at BNP Paribas in New York. This is particularly important as the bespoke tranche market looks to extend from familiar one-to-three-year static deals into longer tenors. “First loss investors can mute their exposure on certain issuers by buying the corresponding CDS protection,” he says. “This is very efficient for two-year structures, however five-year equities tend to be more convex. Giving substitution rights to five-year equity investors allows them to adjust their positions accurately over time.” JP Morgan is thought to favour an investment grade-focused portfolio for its first foray into longer-dated managed CSOs. This could follow a simpler structure than previous bespokes, comprising a big equity tranche with remaining risk sitting in one senior piece. BNP Paribas, by contrast, is considering a 50-50 mix of investment grade and high yield CDS. This could comprise around 100 names and feature a mezzanine piece between equity and senior tranches. Established CLO managers with synthetic credentials are being vetted to take equity in the banks’ planned ventures. In both, while the equity holder will have name substitution rights, it will not receive manager fees in the way a CLO manager expects. “Managed CSO is a misnomer here,” says Mear. “What the market is discussing is how to give first loss investors efficient tools to manage the risk they own. This is very far from external managers charging a performance fee.”

Although discussions have advanced, the tightness of credit spreads presents a challenge. CSO volumes have been hampered since mid-2019 and 2020 has started slowly. But this has at least focused minds on the legal and administrative requirements of making active portfolios a reality.