The International Swaps and Derivatives Association is ready with a standard credit default swaps settlement protocol that can be used with the next credit event. Previously each credit event needed a separate protocol. The new standard protocol is likely to be published by mid-September, but could be used in the interim if a default does take place, said market participants. It would be the first time a protocol is in place to cash-settle single-name CDS. “A draft is very close to being issued,” said one source close to the protocol. “They are crossing the T’s and dotting the I’s.”
Previous cash settlement protocols have included solely tranche and index trades. As under previous procedures, cash settlement would include an auction to determine the recovery value of the bonds. A dispute resolution panel is also planned to be included in the process, although it is unlikely to be ready before the next credit event, said an ISDA spokeswoman. The association is still putting together a shortlist of possible independent arbitrators to sit on the panel.
The protocol also contains an option to physically settle CDS, although the source said the majority of buysiders prefer cash settlement. “More buysiders want cash settlement because more people use CDS to hedge cash positions; the majority of clients that trade CDS do not own the bonds, so they are more interested in cash settlement. It helps the majority of the market achieve their aims,” he said. He added that the option to physically deliver the bonds was added for those who own bonds and want to make sure they are indeed deliverable.
Dealers will determine which obligations are deliverable. The source said the process of determining these obligations was a sticking point in the talks. “Everyone has their own interests in which obligations are deliverable,” he said. Buysiders are excluded from deciding which bonds are deliverable because of the short 30-day time period the market has to settle a trade after a credit event, the ISDA spokeswoman explained.