On July 14, 2009, the International Swaps and Derivatives Association, Inc. (“ISDA”) published the 2009 ISDA Credit Derivatives Determinations Committees, Auction Settlement and Restructuring Supplement (the “July 2009 Supplement”) to the 2003 Credit Derivatives Definitions (the “2003 Definitions”) and the related so-called “Small Bang Protocol.” The July 2009 Supplement extends the auction settlement hardwiring provisions of the 2009 ISDA Credit Derivatives Determinations Committees and Auction Settlement Supplement (the “March 2009 Supplement”) to the 2003 Definitions published in March 20091 to Restructuring credit events. Parties wishing to amend existing and future trades on a multilateral basis to incorporate the July 2009 Supplement may do so by adhering to the Small Bang Protocol as described below. The Small Bang Protocol is open for adherence until 5:00 p.m. New York time on July 24, 2009. The Small Bang Protocol also offers parties a second and final opportunity to adhere to the Big Bang Protocol.
The July 2009 Supplement
The purpose of the July 2009 Supplement is to amend the 2003 Definitions to extend the auction settlement hardwiring process to Restructuring credit events. The earlier March 2009 Supplement established auction settlement as the default settlement method for most credit default swaps but specifically excluded Restructuring credit events from such standard. This exclusion recognized the fact that settlement of “Modified Restructuring” and “Modified Modified Restructuring” credit events differs in a number of respects from the settlement of other credit events. Unlike in the event of a “Failure to Pay” or “Bankruptcy” credit event, the settlement process for Restructuring is subject to different restrictions depending on the scheduled maturity of the credit default swap at issue and whether the protection buyer or seller under the credit default swap declares the credit event. If the protection buyer declares a Restructuring credit event, Modified Restructuring limits the cheapest-to-deliver option in relation to the restructured portion of the reference entity’s outstanding debt obligations by limiting the maximum maturity of deliverable obligations. If the protection seller triggers the Restructuring credit event, these limitations do not apply, owing to the logic that the buyer should have the option to deliver obligations across the credit curve since the protection seller forced the settlement. The exclusion of Restructuring from the March 2009 Supplement also reflects changes in market practices for standard North American corporate credit default swaps to provide for No Restructuring. Auction settlement for Restructuring credit events therefore is of declining relevance at least for North American credit default swaps.
To enable Restructuring credit events to be settled by auction, the July 2009 Supplement groups credit default swaps transactions into different buckets depending on the remaining maturity of those credit default swap contracts. If the protection buyer triggers a Restructuring credit event, deliverable obligations are identified for each bucket by reference to the remaining maturity of the credit default swap, and any deliverable obligations included in a shorter-maturity bucket also are deliverable for all longer-maturity buckets. This categorization also applies to physical or cash settlement if no auction is held.
The auction settlement procedures applicable to Restructuring credit events are not changed from those applicable to other credit events. However, the Determinations Committee (the “DC”) will determine to hold auctions separately for each maturity bucket, based on the volume of outstanding protection written in each relevant bucket. The DC may resolve to hold one or more parallel auctions following a Restructuring credit event for various maturity buckets, and not to hold an auction for one or more particular maturity buckets. In such event, the protection buyer and seller in a transaction that falls within a maturity bucket without auction settlement have a “movement option,” subject to certain limitations, that enables the parties to settle the transaction using the price determined for an alternative auction-settled bucket.
Once the DC has determined that a Restructuring credit event has occurred, one of the parties must trigger the Restructuring credit event for a specific transaction by delivering a credit event notice to the other party. The deadline for furnishing a credit event notice varies depending on whether an auction is held for the relevant maturity bucket and whether the protection buyer or seller triggers the credit event. If a request for determination is not submitted to the DC or the DC declines to resolve a request for determination, a party may trigger its credit default swap by sending a credit event notice and notice of publicly available information directly to its counterparty.
The Small Bang Protocol
Parties to existing trades entered into before July 27, 2009 who wish to give effect to the July 2009 Supplement are given the opportunity to amend their existing trades on a multilateral basis with all other adhering counterparties by adhering to the Small Bang Protocol. The Small Bang Protocol covers the same types of credit derivative transactions that were included in the Big Bang Protocol: most index transactions, swaptions and single name transactions are covered, and loan only transactions, U.S. municipal transactions and CDS on ABS are excluded. In addition, the Small Bang Protocol covers novations and future credit derivative transactions of the covered types that are entered into between adhering parties on or after July 27, 2009 but before January 31, 2011.
Parties who choose to adhere to the Small Bang Protocol must complete and execute an adherence letter and submit scanned original and conformed copies of the letter by e-mail to ISDA. A copy of the text of the Small Bang Protocol and a copy of the adherence letter is available on ISDA’s website, www.isda.org. The Small Bang Protocol opened for adherence on July 14, 2009 and remains open for adherence until 5:00 p.m. New York time on July 24, 2009. Parties may not revoke their adherence.