Catastrophic Effect of Synthetic CDO

The article in the Hedge Systems revealed how damaging Synthetic CDO can be.

Many Minibond collateral were Synthetic CDO and there were no details were disclosed on the Synthetic CDO other than it was a 'AAA-rated (synthetic CDO)'. No information was provided on the number of reference entities, their ratings, the rules for the default-event, etc. 

Banks are expert in buy/selling CDO & CDS & Synthetic CDO & Conventional bonds. From their many years experiences & expertise, Banks SHOULD KNOW that AAA-rated Synthetic CDO is different from AAA-rated conventional bonds. Further,  banks SHOULD KNOW that AAA-rated CDO (in the upfront marketing material) was referring to Synthetic CDO and not referring to the CASH flow CDO. 

While HKMA Mr. Yam was defending banks in legco regarding the disclosure of CDO collateral, he casually forgot that the Minibond CDO collateral was in fact Synthetic CDO, not the Cash-Flow CDO. The two seems sharing similar naming "CDO", but the exact prefix "Cash Flow" (CDO) and the "Synthetic" (CDO) showed their different risk profile. 

Quote from the "Catastrophic Effect of Synthetic CDO":

[ " There is a major difference of Synthesis CDO and Cash Flow CDO.

In the case of Cash flow CDO, managers need purchase the assets first. Then it securitized as CDO to sell investors. ...

Manage of CDO must hold equity piece of  CDO. 

In case of Synthetic CDO, Synthetic CDOs are structured vehicles that use credit derivatives (CDS) to achieve the same credit-risk transfer as cash flow CDOs,  without physically transferring the assets. 

The risk is typically transferred to the investors by the entity holding the physical assets."

]