Feb. 27 (Bloomberg) -- Investors could be forced to wind down as much as $150 billion of collateralized debt obligations if Fitch Ratings' plans for grading the securities are followed by the industry, according Royal Bank of Scotland Group Plc.

Fitch may change its criteria for CDOs backed by company debt to reflect higher risks of default and lower recovery rates. Securities that package credit-default swaps, known as collateralized synthetic obligations, or CSOs, may have their ratings cut by about five levels under the proposals, potentially forcing investors to unravel the trades at a loss.

Speculation that investors are starting to wind down holdings of the securities drove the cost of contracts based on benchmark credit-default swap indexes to record highs last week. Moody's Investors Service and Standard & Poor's haven't announced any changes to the way they rate the securities.

``The problem is that while Fitch rate only 10 to 15 percent of the rated CSO universe, one cannot completely rule out a copy-cat response from Moody's and S&P,'' Royal Bank analysts in London wrote in note published Feb. 25. ``If they did, the whole CSO market could suffer.''

Investors own CSOs based on a notional $1.5 trillion of debt, according to Royal Bank estimates. Downgrades could affect $360 billion of securities.

ITraxx Europe

The Markit iTraxx Europe index of credit-default swaps on 125 companies with investment-grade credit ratings soared to a record 129 basis points on Feb. 20, according to data compiled by Bloomberg. A basis point on a credit-default swap contract protecting 10 million euros ($15 million) of debt from default for five years is equivalent to 1,000 euros a year. The index rose 1.75 basis points to 104.75 at 5 p.m. in London, JPMorgan Chase & Co. prices show.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A decline indicates improvement in the perception of credit quality; an increase, the opposite.

Fitch plans to introduce the new criteria for rating CDOs at the end of March after seeking feedback from market participants. If the firm implements the changes as announced, and Moody's and S&P don't follow suit, investors may unwind at most between $10 billion and $20 billion of CDOs, the Royal Bank note said.

S&P may ``cause a lot of grief in the market'' if it tightens its criteria, the note said.

Moody's doesn't plan to announce any changes to its corporate CDO methodology imminently, said Yuri Yoshizawa, group managing director of the firm's U.S. CDO unit.

Felicity Albert, a spokeswoman for S&P in London declined to comment.

To contact the reporter on this story: Neil Unmack in London at nunmack@bloomberg.net

Last Updated: February 27, 2008 12:05 EST