The International Swaps and Derivatives Association (ISDA) has published a protocol (Small Bang Protocol) which will permit adhering parties to incorporate a new Restructuring Supplement to the 2003 ISDA Credit Derivatives Definitions into existing and new credit default swap (CDS) contracts. In general, the Supplement permits CDS transactions that include restructuring as a credit event to be settled through the auction process that has been hardwired into most CDS transactions.  

This is a positive development for firms that trade CDS on European names for two reasons. First, the bankruptcy laws in Europe vary significantly from country to country, and most of these laws do not permit companies to restructure their debt obligations in the context of a bankruptcy (i.e., it is necessary to include restructuring as a credit event under CDS transactions because the bankruptcy credit event does not necessarily encompass the restructuring of debt obligations). In addition, the Basel II capital adequacy rules provide banks with additional capital relief if their CDS transactions include restructuring as a credit event.  

Under the Small Bang Protocol, an ISDA Determinations Committee will determine whether there has been a restructuring credit event. If this determination is in the affirmative, CDS contracts may be grouped into as many as nine possible buckets depending on maturity. The Determinations Committee will decide which bonds or loans will be deliverable into which maturity buckets. This process is expected to take about two weeks. ISDA will publish the lists of maturity buckets and their deliverables, and buyers of protection or sellers of protection will then have five business days to decide whether to trigger their CDS contracts.  

The Small Bang Protocol also offers parties a second and final opportunity to adhere to the Big Bang Protocol. By adhering to the Small Bang Protocol, a party that did not adhere to the Big Bang Protocol will be deemed to have adhered to the Big Bang Protocol.  

The adherence period for the Small Bang Protocol opened on July 14 and closes on July 24 at 5 p.m. EDT.  

A copy of the Small Bang Protocol may be found here.