Investors and dealers have dismissed rating agency proposals to document credit-default swaps on collateralized debt obligations with a fixed cap and no implied write-down. The lack of a standard for implied write-down provisions in the International Swaps and Derivatives Association confirm for synthetic asset-backed securities trades is viewed as an impediment, but the market has failed to agree on a standard form (DW, 9/15).
Some dealers believe the CDS contracts on the CDOs should compensate for losses on a mark-to-market basis as they occur. Another group thinks the buyer should pay just the fixed-protection premium on the portion of the implied write-down amount. As a result, the market has gravitated toward including an implied write-down with a fixed cap or no implied write-down with a variable cap--but the rating agency combination of a fixed cap and no implied write-down has been roundly rejected. "This is a trade that none of the dealers will do," according to a buy-side investor.
For now, documents are drawn up with varying provisions based on the investor and dealer's preferences. Several structurers noted some trends are developing, however. For example, when writing protection on AA-rated CDOs most investors have elected the fixed option, on A-rated structures it is usually based on where the bonds are currently valued. CDOs rated BBB are causing the most documenting problems because they are the most likely to see losses. So far, the most favored option has been to trade variable cap with implied write-down.
