UK: ISDA Publishes Auction Supplement And Big Bang Protocol

Last Updated: 27 March 2009
Article by Will Dibble and Mark Bines

On 12 March, 2009 the International Swaps and Derivatives Association, Inc. ("ISDA") published the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement Supplement to the 2003 ISDA Credit Derivatives Definitions (the "Supplement") and the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement CDS Protocol (the "Big Bang Protocol"). These are of great importance to those who use Credit Derivatives or related products.

The main purposes of the Supplement and the Big Bang Protocol are to:

  • add the concept of "Auction Settlement" to the 2003 ISDA Credit Derivatives Definitions and so allow parties to settle Transactions through the Auction Settlement process;
  • implement "60 day look-back" provisions with respect to Credit Events, and "90 day look-back" provisions with respect to Succession Events; and
  • establish Credit Derivatives Determination Committees (each a "Committee") for determining matters related to Credit Events and Succession Events and establish certain rules for each Committee (the "DC Rules").

The changes introduced by the Supplement and the Big Bang Protocol will help provide liquidity to the market and ultimately support central clearing. This is because, amongst other things, it shall be possible to have consistent determinations made by a Committee as to whether there has been a Credit Event or Succession Event and because the same Credit Event Backstop Dates and Succession Event Backstop Dates shall apply to all trades.

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Full Article

Overview

On 12 March, 2009 the International Swaps and Derivatives Association, Inc. ("ISDA") published the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement Supplement to the 2003 ISDA Credit Derivatives Definitions (the "Supplement") and the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement CDS Protocol (the "Big Bang Protocol"). These are of great importance to those who use Credit Derivatives or related products.

The main purposes of the Supplement and the Big Bang Protocol are to:

  • add the concept of "Auction Settlement" to the 2003 ISDA Credit Derivatives Definitions and so allow parties to settle Transactions through the Auction Settlement process;
  • implement "60 day look-back" provisions with respect to Credit Events, and "90 day look-back" provisions with respect to Succession Events; and
  • establish Credit Derivatives Determination Committees (each a "Committee") for determining matters related to Credit Events and Succession Events and establish certain rules for each Committee (the "DC Rules").

The changes introduced by the Supplement and the Big Bang Protocol will help provide liquidity to the market and ultimately support central clearing. This is because, amongst other things, it shall be possible to have consistent determinations made by a Committee as to whether there has been a Credit Event or Succession Event and because the same Credit Event Backstop Dates and Succession Event Backstop Dates shall apply to all trades.

We set out more detail on the Supplement and the Big Bang Protocol below.

The Big Bang Protocol

The adherence period for the Big Bang Protocol opened on 12 March 2009 and will close on 7 April 2009. For parties who have adhered to the Big Bang Protocol (each an "Adhering Party") the provisions of the Supplement will be incorporated into Transactions ("Existing Transactions") existing as at 7 April 2009 on 8 April 2009 except for the "60 day / 90 day look back" provisions (as to which see "Credit Events and Succession Events" below) which will be implemented on 20 June 2009. In addition, the provisions of the Supplement will be automatically incorporated into Transactions between Adhering Parties which have Trade Dates between 8 April 2009 and 31 January 2011 (inclusive), except for the "60 day / 90 day look back" provisions with respect to Transactions that reference CDX or iTraxx indices which will be implemented for such Transactions on the later of 20 June 2009 and the Trade Date. The reason that the Big Bang Protocol will apply to certain future Transactions up to 31 January 2011 is to give ISDA time to update its standard documentation to incorporate the provisions of the Supplement. In respect of Transactions that have Trade Dates after 31 January 2011, market participants will need to execute Confirmations that expressly include the provisions of the Supplement in order to incorporate its provisions. Where Transactions are amended by the Big Bang Protocol, all Transactions are amended so that Auction Settlement is the primary Settlement Method.

Certain types of Transactions are excluded from and will not be amended by the Big Bang Protocol. These include (i) "Loan Only Transactions" which are Transactions which have "Loan" specified as the only Deliverable Obligation Category or Transactions pursuant to which the Reference Obligations and certain other Loans are the only Deliverable Obligations; (ii) "US Muni Transactions" which essentially relate to Transactions that have US Municipal Entities as Reference Entities; (iii) CDS Transactions where any Reference Obligation or Deliverable Obligation is an asset-backed security, mortgage-backed security and/or collateralised debt obligation; and (iv) any back-to-back Transaction between any two of Citigroup Global Markets Limited, Credit Suisse First Boston International, Deutsche Bank AG, Goldman Sachs International, JPMorgan Chase Bank, Merrill Lynch International, Morgan Stanley Capital Services Inc. and UBS AG London Branch relating to trust certificates linked to any Dow Jones CDX.NA.HY Index or CDX.NA.HY Index. In addition, any Adhering Party may agree with any other Adhering Party to exclude one or more Transactions from the operation of the Big Bang Protocol.

The Supplement

Amongst other things, the Supplement adds a new Section 12 to the 2003 ISDA Credit Derivatives Definitions (but, for the avoidance of doubt, not the 1999 ISDA Credit Derivatives Definitions) which provides that the parties can select the new method of Auction Settlement to settle Transactions in addition to Cash Settlement and Physical Settlement. Auction Settlement allows a settlement price to be determined by reference to any auction that may be held without the requirement for the parties to a Transaction to sign up to a specific auction protocol. Certain Transactions, such as Fixed Recovery Transactions, Reference Obligation Only Transactions and certain bespoke Transactions, are not suitable for the Auction Settlement process and so the settlement price for such Transactions will still be determined by either Cash Settlement or Physical Settlement.

If the parties select Auction Settlement as the method of settling a Transaction and a Credit Event occurs with respect to the relevant Reference Entity, the parties agree to settle that Transaction in accordance with the relevant Auction. Alternatively, if:

  • ISDA announces that an Auction will not be held with respect to a particular Reference Entity;
  • an Auction is cancelled;
  • ISDA announces that the relevant Committee has resolved not to determine whether or not an event constitutes a Credit Event;
  • ISDA announces that a Restructuring Credit Event has occurred; or
  • a party to a Transaction delivers a Credit Event Notice and, if applicable, a Notice of Publicly Available Information and no Eligible Market Participant (as defined below) has requested that a Committee be convened by ISDA within three Business Days of such delivery,

the parties will settle the relevant Transaction in accordance with the "Fallback Settlement Method" which shall be Physical Settlement unless the parties state that Cash Settlement will apply as the Fallback Settlement Method.

The Supplement also contains as Annex B, a form of Auction Settlement Terms and it is intended that the Auction methodology contained therein remains largely consistent from Auction to Auction with amendments only being allowed by a "Supermajority" vote of the relevant Committee (as further described below). The Auction specific terms for each Auction (such as the Auction Date and Event Determination Date) shall be determined by the relevant Committee by majority vote for each Auction (as further described below). In addition, the Deliverable Obligations in respect of each Auction shall be determined by the relevant Committee.

Credit Events and Succession Events

As noted above, the Supplement and Big Bang Protocol implement "60 day look-back" provisions with respect to Credit Events and "90 day look-back" provisions with respect to Succession Events. This means that on any particular day during the term of a Transaction a Credit Event can be recognised for the purposes of a transaction only if the relevant event occurred no more than 60 days prior to the date on which a request to the relevant Committee was determined to be effective or the date on which both a Credit Event and Notice of Publicly Available Information are submitted. Similar provisions apply in respect of Succession Events where the relevant period is 90 days. These "look-back provisions" essentially act as a form of statute of limitations with respect to Credit Events and Succession Events. Please note that such provisions allow for a Credit Event or Succession Event to occur prior to a Transaction's Trade Date. This contrasts with the current position where the Effective Date for both Credit Events and Succession Events is specified in the relevant Confirmation and the Seller is on risk for the entire term of the Transaction.

DC Rules

Annex A of the Supplement sets out the DC Rules for determining certain matters including whether to hold an Auction and Succession Events.
On 31 March 2009 and on the New York Business Day occurring on or immediately prior to 30 March of each calendar year thereafter, ISDA, as the DC Secretary, shall identify for each Region (being the Americas, EMEA, Asia Ex-Japan, Australia-New Zealand and Japan):

  • potential voting members for a Committee comprising eight global dealers, two regional dealers in respect of each Region and five non-dealers with each such member being a "Designated DC Voting Member"; and
  • potential consultative members for a Committee comprising one global dealer, one regional dealer and one non-dealer with each such member being a "Designated Consultative Member".

Any market participant that has entered into a Credit Derivatives Transaction that has (or is deemed to have) incorporated the Supplement (an "Eligible Market Participant") may request a Committee to be convened to address a specific question (a "DC Question") by notifying ISDA who then notify each relevant Designated DC Voting Member (each such Designated DC Voting Member being a ("Convened DC Voting Member") and each relevant Designated Consultative Member (each such Designated Consultative Member being a "Convened DC Consultative Member"). If one Convened DC Voting Member agrees that the question warrants the convening of the relevant Committee (which shall depend on the Region of the Reference Entity), then the relevant Committee is convened ("Convened DC").

The relevant Committee can determine matters such as:

  • whether a Potential Failure to Pay or a Potential Repudiation / Moratorium has occurred with respect to a particular Reference Entity;
  • whether a Credit Event has occurred with respect to a particular Reference Entity;
  • the date of occurrence of such Credit Event;
  • whether to hold one or more Auctions;
  • whether to amend the Auction methodology; and
  • which Obligations of the relevant Reference Entity will be treated as Deliverable Obligations for the purposes of the relevant Auction.

Certain matters are required to be determined or resolved by a "majority" (i.e. more than 50% of the Convened DC Voting Members) and certain matters are required to be determined or resolved by a "supermajority" (i.e. at least 80% of the Convened DC Voting Members) with each resolution of a DC being a "DC Resolution".

A majority is required for DC Resolutions in respect of matters such as whether to hold one or more Auctions and the Auction specific terms, as noted above. A supermajority is required for DC Resolutions in respect of most of other matters including (i) whether a Credit Event has occurred, (ii) the date of the occurrence of a Credit Event, (iii) the determination of the Final List of Deliverable Obligations, as noted above, and (iv) changes to Auction methodology with any such changes only being made following public consultation.

For certain DC Questions requiring a supermajority that are not determined with a requisite number of votes (i.e. 80% of the Convened DC Voting Members), such DC Questions shall be referred for external review as "Reviewable Questions". It is anticipated that the external reviewers will be derivatives lawyers or retired judges.

Any Decision of the external reviewers shall constitute a DC Resolution. All DC Resolutions, whether determined by the Convened DC Voting Members or by External Review, shall be binding in respect of all Transactions that incorporate the Supplement and shall be published on ISDA's website.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 26/03/2009.

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