a&o isda auction hard wiring (march 2009)
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ISDA Auction Hardwiring
18 March 2009
SHRUTI AJITSARIA
Senior Associate, United Kingdom
DAVID BENTON
Partner, United Kingdom
DAVID LUCKING
Partner, United States
JOHN WILLIAMS
Partner, United States
ISDA publishes supplement to the 2003 ISDA Credit Derivatives Definitions and "Big Bang" protocol.
On 12 March 2009, the International Swaps and Derivatives Association, Inc. (" ISDA") published the following new
documentation that effects a number of key changes for certain credit derivatives products, particularly credit
default swaps, but also credit-linked products such as new credit-linked notes and synthetic CDOs:
2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement Supplement to the 2003 ISDACredit Derivatives Definitions (the "Supplement ")
2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement CDS Protocol (the "Protocol ")
The Supplement introduces three new concepts to the 2003 ISDA Credit Derivatives Definitions (the "2003
Definitions "):
Credit Derivatives Determinations Committees (the "DeterminationsCommittee(s) ")
a new settlement method for credit derivative transactions, known as auction settlement
new provisions for taking into account the occurrence of credit events and succession events by operation oflook-
back dates that require action by a party to a credit derivative transaction within 60 or 90 calendar days, respectively,of the occurrence of the relevant event in order for such event to affect such credit derivative transaction
Credit Derivatives Determinations Committees
Composition:
The Supplement establishes 5 regional Determinations Committees that will be tasked with making determinations
of general importance to the credit derivatives market, including:
whether a credit event has occurred
whether to hold an auction to settle a credit event
the obligations to be valued in any auction held to settle a credit event
whether a succession event has occurred
the identity of any successor
A Determinations Committee will be formed for each of the following 5 regions:
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Americas
Europe, Middle East and Africa
Japan
Australia and New Zealand
Asia excluding Japan
Each Determinations Committee will consist of:
8 global dealer voting members
2 regional dealer voting members for the relevant region
5 global non-dealer voting members
certain non-voting consultative dealer and non-dealer members
Each member generally serves a one-year term, with non-dealer members serving on a staggered one-year basis.
Dealer members are chosen based on trading volume, whereas non-dealer members are chosen at random from
a pool of non-dealer institutions that have the required amount of assets under management and derivative
exposure.
The Determinations Committee for the relevant region will be convened each time a question is submitted to ISDA,
as secretary of each Determinations Committee, as long as one member of the relevant DeterminationsCommittee believes that such question merits deliberation.
Each Determinations Committee must reach at least 80 per cent consensus in order to pass the most important
decisions. Should any such question attain less than an 80 per cent supermajority vote, it will be referred to a
panel of external reviewers chosen randomly from a pool composed of individuals nominated by ISDA members
and approved by a majority of the members of the relevant Determinations Committee.
Effect of Determinations Committee Decisions
Each decision of a Determinations Committee will be binding, to the extent relevant, on parties to a credit
derivative transaction that incorporates the Supplement (including by operation of the Protocol) unless such partiesbilaterally agree at the relevant time to disapply the relevant Determinations Committee's decision, provided that a
determination by a Determinations Committee, or a calculation agent, of the identity of a successor, a substitute
reference obligation or certain other matters, such as the determination that a credit event has occurred that has
resulted in a settlement, may not be reversed by a subsequent determination of a Determinations Committee.
Each Determinations Committee has the power to refuse to decide a question or to dismiss a question, in which
case the parties must reach their own conclusions on the relevant question (or the calculation agent will make the
relevant determination) in the same way as they do under the 2003 Definition.
Joining the Determinations Committees
To participate on the initial Determinations Committees:
dealer institutions must submit a dealer participation letter to ISDA by March 25, 2009
non-dealer institutions must submit a non-dealer committee participation letter to ISDA by March 20, 2009
Templates of these letters are available at www.isda.org . Submission of these letters does not guarantee a position
on a Determinations Committee. Successful applicants will be notified that they have been selected to serve on
the initial Determinations Committee(s) by April 7, 2009, at which point they must also agree to be bound by the
rules of the relevant Determinations Committee by executing an agreement between ISDA and the other
committee members.
Auction Settlement
The process of holding auctions to determine a settlement price in respect of a credit derivative transaction
following the occurrence of a credit event has functioned smoothly since its inception in 2005 as the primary
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settlement method for credit events on widely traded reference entities. As a result, ISDA has facilitated, at the
request of regulators in the U.S. and Europe, the "hardwiring" of auction settlement as a new settlement method
into the documentation for corporate and sovereign credit derivative transactions. It is expected that auction
settlement will swiftly become the market standard settlement method in the over-the-counter credit derivatives
markets and that auction settlement will also be adopted in other credit-linked products.
The ability to elect auction settlement as the settlement method at the time a credit derivative transaction isentered into obviates the need for parties to adhere to an auction settlement protocol each time a credit event
occurs. Instead, ISDA has published, as Annex B to the Supplement, a form of auction settlement terms that are
based on the settlement methodology applied in recent auction settlement protocols, and that will be used as the
basis for the auction settlement terms that are published each time the relevant Determinations Committee
determines to hold an auction with respect to a credit event. For each auction, the Determinations Committee will
determine certain auction-specific terms, as well as deliverable obligation terms and a list of deliverable obligations
to be valued in the auction. A credit derivative transaction that has auction settlement as its primary settlement
method will automatically be settled by reference to the settlement price determined under any such auction,
although certain types of credit derivative transactions are excluded from the auction settlement process,
including:
reference obligation only transactions
fixed recovery transactions
transactions for which the provisions for identifying deliverable obligations are different from the market standardprovisions for credit derivative transactions referencing the relevant entity
transactions for which auction settlement is specified as the settlement method but that the parties have subsequentlyagreed to exclude from the auction process
Credit Event and Succession Event Backstop Dates
Under the 2003 Definitions, a credit event that occurs on or after the effective date of such credit derivative
transaction may trigger settlement. While this trading convention has long provided flexibility to buyers of
protection, the practice prevents two credit derivative transactions that are identical, but for their effective date,from being fungible, since the transaction with the earlier effective date may have experienced credit events or
succession events that would not impact the credit derivative transaction with the later effective date.
To remove this potential for lack of fungibility between credit derivative transactions with otherwise identical terms,
the Supplement provides that any credit event that occurred more than 60 calendar days prior to the date on which
a request is submitted to ISDA for the relevant Determinations Committee to consider whether a credit event has
occurred will not be able to trigger settlement of a credit derivative transaction, unless the parties thereto have
already exchanged notices with respect to such event.
For succession events the look-back period is 90 calendar days and functions similarly.
These changes mean that parties face a time limit on their ability to act on a credit event or succession event
under their contracts. The changes also mean, however, that it is possible that, unlike under the 2003 Definitions,
a credit derivative transaction could be affected by a credit event or succession event that took place before the
trade date or the effective date of such credit derivative transaction.
"Big Bang" Protocol
A wide range of credit derivative transactions that are in existence as of April 7, 2009 are to be amended such that
the provisions of the Supplement, imported into the 2003 Definitions, will be deemed to apply to such credit
derivative transactions. Amendment to such a broad range and large number of existing credit derivative
transactions is to be achieved by operation of the market-wide Protocol. The Protocol seeks to amend the mostcommon types of credit derivative transactions that reference corporate and sovereign entities, not including :
loan-only credit derivative transactions
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credit derivative transactions referencing U.S. municipalities
credit derivative transactions referencing asset-backed securities and similar securities
credit derivative transactions that parties separately agree to exclude from the scope of the Protocol
Unlike previous ISDA protocols, the Protocol also seeks to amend, prospectively, certain types of credit derivative
transaction that are typically documented using market standard documentation. To the extent that two adherents
to the Protocol enter into a credit derivative transaction on or afterApril 8, 2009, and such adherents document
such credit derivative transaction without separately incorporating the supplement, such market standarddocumentation will be deemed to have been amended to implement the changes to the 2003 Definitions
contemplated by the Supplement and to hardwire auction settlement as the primary settlement method.
The Protocol is open for adherence through April 7, 2009 via an adherence letter available on the ISDA
website. The adherence letter should be submitted to ISDA [email protected]
The Protocol implements the application of certain provisions of the Supplement on a staggered basis as follows:
Determinations CommitteesApplicable to each covered credit derivative transaction in existence on April 7, 2009 (each, a "LegacyTransaction") from April 8, 2009
Applicable to each covered credit derivative transaction entered into on or afterApril 8, 2009 (each, a "NewTransaction") from the date the relevant credit derivative transaction is entered into
Auction SettlementApplicable to each Legacy Transaction from April 8, 2009
Applicable to each New Transaction from the date the relevant New Transaction is entered into
60/90 Day Look-back DatesApplicable to all New Transactions (other than New Transactions that reference credit indices such as CDXand iTraxx) from the date the relevant New Transaction is entered into
Applicable to each Legacy Transaction from June 20, 2009
Applicable to each New Transaction that references a credit index such as CDX and iTraxx from the later ofJune 20, 2009 and the date the relevant New Transaction is entered into
Note that, because most of the changes to credit derivative transactions effected by the Supplement and Protocol
will take effect for new credit derivative transactions (other than those referencing a credit index) beginning on
April 8, 2009, market participants who enter into credit-linked transactions or issue credit-linked notes for which
they intend to hedge their exposure in the credit derivatives market on or after April 8, 2009 will need to take
account of the impact of these new provisions and should consider incorporating these provisions into their
transactions.
If you have any questions about the information contained in this article, feel free to contact one of the individuals
listed above or your usual Allen & Overy advisor.
Allen & Overy LLP 2006-2011. All rights reserved
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