Broad Index Secured Trust Offering (BISTRO)

What Was a Broad Index Secured Trust Offering (BISTRO)?

A broad index secured trust offering (BISTRO) was a proprietary name used by J.P. Morgan for creating collateralized debt obligations (CDOs) from credit derivatives. About a week before Christmas 1997, J.P. Morgan launched the Broad Index Secured Trust Offering (BISTRO), a $700 million bond issue referencing a portfolio of more than 300 corporate and public finance credits across Europe and North America.

The structure of BISTROs allowed financial institutions to hedge economic risk while simultaneously releasing regulatory capital. These offerings were the predecessor of the synthetic collateralized debt products that later grew in popularity. These debt products were credited with contributing to the 2007-2008 financial crisis.

Understanding a Broad Index Secured Trust Offering (BISTRO)

The Broad Index Secured Trust Offering (BISTRO) was considered a landmark financial instrument at the time of its launch; it was believed to be one of the first synthetic collateralized debt obligation (CDO) instruments ever created.

About a week before Christmas 1997, J.P. Morgan launched the Broad Index Secured Trust Offering (BISTRO), a $700 million bond issue referencing a portfolio of more than 300 corporate and public finance credits across Europe and North America. As such, such instruments helped transform the modern banking industry. The finance industry had used synthetic currency swaps — agreements to exchange debt obligations and future cash flow in different currencies and swaps of bonds and interest rates — since the early 1980s. A BISTRO represented an evolution of this idea. 

Rather than swapping currency or bond income, J.P. Morgan proposed exchanging the risk of default. The swaps would be synthetic, or artificially simulated. The bank would pool several different debt obligations of loans and bonds, then allow investors to invest in bundles of credit-default swaps. The structure allowed the bank to shift risk to the investors while also generating income from selling that risk.

“The overarching motivation for BISTRO wasn’t to open up a new market or sell some funky product, but for JP Morgan to hedge its credit risk,” said Bill Winters, a former co-chief executive of J.P. Morgan’s investment bank, told the International Financing Review in an interview. “It was extremely effective in accomplishing that. It also had the effect of spawning a new industry.”

A History of the BISTRO

The initial broad index secured trust offerings came to market in December 1997 and referenced an underlying portfolio of 307 commercial loans, as well as corporate and municipal bonds. The U.S. Federal Reserve permitted J.P. Morgan to secure regulatory capital for its BISTRO deals. These offerings were extremely popular with investors, and four more broad index synthetic trust offerings followed over the course of the next 12 months.

The structure of BISTROs remains one of the most controversial capital market inventions ever created.

Initially created as a way for J.P. Morgan to hedge its credit risk, these offerings ultimately opened up a large new market in the financial industry. Following the introduction of BISTRO, other financial institutions offered similar products and developed copycat structures.

Consequences of BISTROs

The introduction of BISTROs has been credited with ushering in the era of synthetic collateralized debt obligations (CDOs), which used credit derivatives to transfer credit risk in a portfolio. The market for synthetic CDOs grew substantially in the beginning, rising from $10 billion in 2000 to $105 billion in 2007.

Some financial institutions began to create synthetic CDOs that included somewhat dubious real estate assets — such as subprime mortgages — in their underlying reference pools. In the wake of the 2007-2008 financial crisis, experts argued that by allowing banks to shift risk, synthetic CDOs contributed to the financial crash.