Alert April 14, 2009

Big Bang Protocol for Credit Derivatives Becomes Effective

April 8, 2009 was the effective date for the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement CDS Protocol, also known as the “Big Bang Protocol” (the “Protocol”).  The Protocol was open for adherence by parties to existing credit default swaps from March 12, 2009.  Signing on to the Protocol permitted parties to incorporate the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement Supplement to the Definitions (referred to as the “March 2009 Supplement,” which supplements the 2003 ISDA Credit Derivatives Definitions (referred to as the “Definitions”)) and to adopt credit event and succession event backstop dates into their existing transactions and credit derivative transactions (also referred to as credit default swaps or CDS) that are new or novated between April 8, 2009 and January 31, 2011.  The International Swaps and Derivatives Association, Inc. (“ISDA”) announced that as of April 8, 2009, more than 2,000 market participants agreed to adhere to the Protocol.

The Protocol introduces three components to the CDS market (summarized with bullets and further described below) aimed at increasing fungibility among certain credit derivatives transactions.

  • A structure of five regional Credit Derivatives Determinations Committees (“DCs”) comprised of dealer and buy-side representatives. 
  • The establishment of credit event and succession event backstop dates (60/90 days, respectively) so that different transactions will have effective credit events and succession events notwithstanding that they have different trade dates and termination dates.
  • The addition of “Auction Settlement” as a settlement method in order to “hard wire” much of current practice into a consistent settlement methodology across auctions, with auction-specific terms and deliverable obligations to be among the matters determined by the DCs.

Credit Derivatives Determinations Committees.  The March 2009 Supplement establishes five regional DCs and provides that the resolutions of the DCs are binding on all covered transactions (i.e., transactions that have incorporated the March 2009 Supplement).  Any ISDA member may request that a DC address a specific question with respect to covered CDS transactions or the market generally.  The March 2009 Supplement sets forth timelines under which a DC must respond and resolve any question.  To the extent that a DC is not able to obtain an 80% supermajority vote with respect to any issue it considers, that issue will automatically go to an external review panel consisting of individuals chosen randomly from a pool nominated by ISDA members and approved by a majority of the members of the relevant DC.  ISDA will publish all resolutions and decisions by DCs on its website.  The DCs’ binding determinations with respect to certain conditions and events will supersede the role of a transaction’s calculation agent with respect to certain terms, thus moving the CDS market toward increased standardization.

The five DCs are for the Americas, Japan, EMEA (Europe, Middle East and Africa), Asia (less Japan) and Australia-New Zealand, and each DC will resolve issues relevant to the particular credit derivatives market in its region.  Each DC will consist of eight global dealer voting members, two regional dealer voting members for the relevant region, five global non-dealer (i.e., buy-side) voting members and certain non-voting dealers and buy-side members as alternates.  To qualify to become a member of a DC, a buy-side institution must (i) have at least US$1 billion of assets under management, (ii) have single-name CDS transaction exposure in excess of US$1 billion in notional amount, (iii) receive the approval of 1/3 of the then-current buy-side committee, and (iv) adhere to the Protocol.  A non-dealer may be selected as a member of the DC non-dealer committee by providing a written summary of its experience in the credit derivatives market and a written certification of the above-mentioned criteria.  For a dealer to qualify to become a member of a DC, it must (i) serve as a participating bidder in the auctions relating to the Protocol, (ii) adhere to the Protocol and (iii) maintain certain credit default swap notional trade volumes based on Depository Trust & Clearing Corporation data.

Credit Event and Succession Event Backstop Dates.  A Credit Event Backstop Date is 60 days prior to (i) the date of submission of a request to the DC regarding that credit event or (ii) the date of delivery of both a Credit Event Notice and, if applicable, a Notice of Publicly Available Information (each as defined in the Definitions, as amended by the March 2009 Supplement).  A Succession Event Backstop Date is 90 days prior to (i) the submission date of a request to the DC regarding that succession event or (ii) the delivery date of a Succession Event Notice (as defined in the Definitions, as amended).  Accordingly, a credit event occurring prior to the 60-day look-back, or a succession event occurring prior to the 90-day look-back, will have no impact on a transaction that incorporates the Definitions, as amended by the March 2009 Supplement, even if such event takes place within the term of that transaction.

Standardized look-back periods applicable to all covered CDS transactions (replacing unique periods defined by each transaction’s effective date and termination date) result in a greater number of offsetting trades, facilitating compression (or “tear-ups”) and increased flexibility in hedging.  In consideration of this substantial change to the rights of parties to existing transactions, Credit Event and Succession Event Backstop Dates will not take effect for existing transactions until June 20, 2009 in order to allow parties to inform the DC of any relevant credit event or succession event (even if such event occurs outside the 60/90 look-back period).

Auction Settlement.  The addition of “Auction Settlement” as a new settlement method is also referred to as “auction hardwiring.”  After April 8, 2009, parties to a covered transaction (i.e., a credit derivative transaction that incorporates the Definitions as amended by the March 2009 Supplement) may elect to settle their transaction through a relatively standardized auction process, conducted by the applicable DC.  Specific terms and deliverable obligations for an auction will be determined by the DC and published by ISDA in the form of Schedule 1 and Schedule 2 to the Credit Derivatives Auction Settlement Terms.  

Application of the Protocol.  The Protocol applies to covered index transactions, covered swaption transactions and covered non-swaption transactions, as well as covered non-auction transactions (e.g., Reference Obligation only, Fixed Recovery, Preferred CDS, or Party Specified Non-Auction Transactions).  Covered non-auction transactions will incorporate the March 2009 Supplement (i.e., including the provisions relating to DC determinations) but will not specify Auction Settlement.  The following credit derivative transactions are excluded from the scope of the Protocol and will not be amended to incorporate the provisions of the March 2009 Supplement unless the parties bilaterally agree otherwise:

  • Loan only credit derivative transactions;
  • Credit derivative transactions referencing U.S. municipalities;
  • Credit derivative transactions referencing asset-backed securities and similar securities; and
  • Index transactions entered into between two of the main dealers (listed in the Protocol) relating to trust certificates linked to any Dow Jones CDX.NA.HY Index or CDX.NA.HY Index.

Additionally, parties to any transaction may agree bilaterally that their transaction will not be covered by the Protocol Auction Settlement.