ISDA®

The New CDS Landscape

Auction Settlement

International Swaps and Derivatives Association, Inc.

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Copyright © 2009 International Swaps and Derivatives Association. Inc.

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Agenda

• The ISDA Credit Derivatives Determinations Committee and Auction Settlement Supplement

• The ISDA Determinations Committee• Changes to the Auction Settlement Mechanism• Credit and Succession Event Backstop Date

Provisions• The ‘‘Big Bang’’ Protocol• Questions

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The Supplement• Structural Framework

• Supplement to the 2003 ISDA Credit Derivatives Definitions (the “Definitions”)

• Two Annexes• Future transactions should incorporate

the Supplement to the Definitions

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The Supplement• Incorporates the Resolutions of the Determinations

Committees into the Definitions• Adds concept of Auction Settlement as a

Settlement Method• Adds Credit and Succession Event Backstop Dates

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The Determinations Committee Rules

• Structure of the Determinations Committees

• A DC will be formed for each of the Regions

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The Determinations Committee Rules

• Dealer Criteria for Inclusion on a DC• Buyside Criteria for Inclusion on a DC

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The Determinations Committee Rules

• DC Resolutions– Any market participant may request a DC to be

convened to address a specific question– Each DC Member is required to vote in all

binding votes (with one absence allowed per year)

– DC Resolutions will be binding on all transactions which have incorporated the Supplement

– Types of question that the DC will determine

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Review of Decisions• A DC Question will automatically go to External

Review if:• A DC holds a binding vote on questions • AND an 80% supermajority is not achieved

The Determinations Committee Rules

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• Selection of External Reviewers– Nominated to the pool by any ISDA member– 5 External Reviewers selected once a question is

referred, 3 of which will serve– Selected External Reviewers must disclose

potential conflicts of interest

The Determinations Committee Rules

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• External Review Process – Members of a DC supporting each

position choose Advocates to represent them

– External Review Schedule– External Reviewers may only consider

information that was available to the DC at the time of the binding vote held with respect to the relevant question

The Determinations Committee Rules

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• General Provisions– The DC Secretary will publish certain

information– Amendments to the Rules require

Supermajority approval of each DC– Deliberations confidential until relevant

information made public– Market participants waive liability of the DC

Parties and third parties hired under the Rules

The Determinations Committee Rules

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Auction Settlement Terms

• Auction Settlement Terms will be published for each Auction the DC determines should be held

• Auction-specific terms set by the DC by majority vote

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Auction Settlement Terms• Auction Terms Documentation Structure

• Auction methodology contained in main section of document designed to remain largely consistent from Auction to Auction

• Auction-specific terms in Schedule 1• Deliverable Obligations in Schedule 2

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• Dealers or customers may submit Physical Settlement Buy/Sell Requests, orders to trade obligations of a stated size at the Auction Final Price, which create an Open Interest

• Dealers or customers may submit Limit Orders to clear the Open Interest

• RAST is a credit default swap, but on terms such that it takes effect as a bond sale and purchase of cheapest to deliver Deliverable Obligations, at Final Price, and with standard CDS non-delivery fall-backs.

Review of Auction Methodology

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Review of Auction Methodology

• Auction Outputs– Transactions covered by the Auction (i.e. existing trades) cash

settle at the Auction Final Price on the Auction Settlement Date– Trades formed in the Auction, all Physical Settlement Requests

between a customer and a Dealer and all Limit Bids that are cleared in the Auction are matched to form RASTs, which are settled by the relevant participants directly.

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Changes to Loan Settlement• Loan settlement is a difficult, time consuming process, exacerbated in the auction

settlement protocols by the resultant chains of delivery that are often created between customers and Participating Bidders, where the same loan must be settled multiple times to reach the ultimate Seller of protection. The Auction Supplement will allow for a revised, more efficient process:

– Voluntary compression: assuming a settlement chain of Customer 1 (C1) → Dealer 1 (D1) → Dealer 2 (D2) → Customer 2 (C2), if C1 and C2 consent, D1 can designate C1 to make Delivery of the Loan directly to C2. Similarly, D2 can designate C2 to take delivery from D1.

– Any designated party may opt out of such designation, in which case the next person in the chain may be designated to effectuate compression. eg. If C2 will not accept Delivery from C1, D2 may be designated by D1 to take such Delivery (subject to D2 exercising its right not to be designated).

– Parties in the compressed settlement chain make payment of the Physical Settlement Amount to their original counterparty, preventing the creation of new counterparty credit risk.

– For any links in the chain where Delivery of the Loan fails, Cash Settlement pursuant to a revised version of Section 9.3 (Partial Cash Settlement Terms) will apply.

• Documentation for Loan Settlement – the Determinations Committee can approve a Market Advisory. If approved, the terms of the Advisory will be binding and incorporated into the settlement of loans under the relevant auction.

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Provisions seeking to achieve fungibility

• Credit Event and Succession Event Backstop Date provisions:– To be effective, a Credit Event must occur no more than 60 days prior to

notice to the DC

– To be effective, a Succession Event must occur no more than 90 days prior to notice to the DC

– Credit Events and Succession Events may be effective even if they occur prior to the Trade Date

• “Trade Date” references are deleted in certain instances

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“Big Bang” Protocol• Purpose: Incorporate Supplement terms into

Covered Transactions– Entire Supplement made applicable to all Covered

Transactions except Covered Non-Auction Transactions

– Determinations Committee and Auction Settlement effective from First Implementation Date (April 8)

– Credit and Succession Event Backstop Date deemed to be the Effective Date of the CDS until Second Implementation Date (June 20)

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“Big Bang” Protocol

• Scope of Coverage– Broad coverage of a wide range of transaction types – similar

to prior Auction Protocols– Market Standard Documentation deemed amended

prospectively until Jan 1, 2011– Novated Transactions between Adhering Parties are Covered

Transactions until Jan 1, 2011

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“Big Bang” Protocol

• For each Covered Transaction:– Each party to the Transaction must adhere to

the protocol (prior to the Cut-off Date)

• For each legacy trade:– The Trade Date and Effective Dates must be

before the Implementation Date– The Scheduled Termination Date must be on

or after the Implementation Date– No EDD or ETD shall have occurred prior to

the Implementation Date.

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Adherence Process• Adherence letters to be sent to ISDA• Free to adhere• Protocol text to be published on ISDA’s website• Adherence opens March 12 and closes April 7• Determinations Committee and Auction Settlement

Changes take effect April 8 (First Implementation Date)• Credit Event and Succession Event Lookback provisions

take effect June 20 (Second Implementation Date)

“Big Bang” Protocol

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Questions?