Derivative Product Company (DPC) are credit enhanced financial institutions or corporations that act as a counterparty for transactions of business derivatives. They also take part in credit sensitive derivative instruments. DPCs are usually subsidiary of a financial intermediary and also carry high credit rating than that of the parent company. At the same time, DPCs are shielded as much as possible from the parent company’s liabilities. Derivative Product Company is also referred to as Credit Enhanced Vehicle and Special Purpose Vehicle.
The Derivative Product Company is a highly influenced business and even if there is a small change or default in the credit default portfolio, the company will be more affected and will not have enough money to pay the claims. DPCs are also dependent on the ratings that are given to these companies by Rating agencies.
In 2002, the first DPC was established. DPC is a place where the derivative product originates. Other than this, DPC also guarantees existing derivative products and at times, also does a mediation job between two parties during the transaction of derivative products. As the primary focus of these companies is in credit derivatives, they are also referred to as “Credit Derivative Product Company (CDPC)”. But there are also times where a DPC is involved in equity derivatives market, currency market or interest rate.
Types of DPCs
There are basically two types of DPCs – Termination DPCs and Continuation DPCs. They are classified into 2 types because of the trigger events happening related to the Sponsor. In the case of a triggering event in termination DPC, all the DPC trades will terminate for both the Sponsor and Counterparty. But in the case of the continuation DPC, a trigger will lead to the termination of Sponsor trades but the counterparty trades will still be in place. All the counterparty transactions will be managed and will be re-hedged by a contingent manager.
As Discussed, the Derivative Product Companies are highly dependent on the credit rating from the rating agencies. If the DPCs comply with the criteria set by the rating agencies, then the credit ratings will be good and will also exceed the rating of the sponsor. There are some important rating agencies like the Standard & Poor’s Rating Service (S&P), Moody’s Investors Service (Moody’s) and Fitch’s Rating (Fitch) who have separate guidelines for rating the DPCs. The guidelines of these agencies are almost similar with few exceptions.
The Sponsors of the Derivative Product Companies are those who take the decision of pursuing with a particular rating agency. The decision is dependent on the guidelines of the agencies. For more information about DPCs and their rating, contact helpdesk of the Millionaire Blueprint.