ISDA Announces Various Changes to the Legal and Operational Infrastructure of Credit Default Swaps with a View Towards Fungibility of Trades
Hedge Fund Law Report
In recent weeks, the International Swaps and Derivatives Association (ISDA) announced and published various actions designed to substantially revamp the legal and operational framework of the derivatives markets generally, and the credit default swaps (CDS) market specifically. ISDA’s various efforts all appear aimed at the same objectives: (1) to advance the standardization and fungibility of CDS trades in response to calls from politicians and some industry participants for central clearing of CDS, and (2) to enhance the overall transparency and predictability in the CDS markets. The changes initiated by ISDA include the following: (1) “hardwiring” Auction Settlement into new CDS trades by adding a supplement to the 2003 ISDA Credit Derivatives Definitions; (2) establishing Credit Derivatives Determinations Committees (CDDCs) to, at the request of a CDS market participant, oversee the settlement auctions and make certain determinations with respect to CDS trades; (3) facilitating the amendment of outstanding CDS trades to incorporate the provisions for Auction Settlement and CDDCs – the so-called “Big Bang Protocol”; (4) proposing certain market practice changes with respect to North American CDS; and (5) publishing, on February 27, 2009, its Close-Out Amount Protocol, which generally enables parties to amend the 1992 ISDA Master Agreement to provide for determination of termination payments according to the “Close-Out Amount Method” used in the 2002 ISDA Master Agreement rather than the 1992 ISDA Master Agreement’s “Market Quotation” or “Loss” methods. We discuss each of these actions in detail, and outline considerations for hedge funds in connection with the Close-Out Amount Protocol.