Dealers structuring collateralized debt obligations are re-jiggering the International Swaps and Derivatives Association pay-as-you-go settlement template--designed for asset-backed structures--to use it for corporate-linked structures. In particular, lawyers say dealers are refining and adapting the PAUG documents to account for implied write-downs in synthetic CDOs, CDOs of ABS that include CDOs as subcategories and CDO-squared transactions.
Dealers--protection buyers--prefer PAUG settlement to straight cash settlement because it requires sellers to pay if the reference obligation experiences interest shortfalls, principal shortfalls or implied write-downs, and it allows buyers to reduce all or part of the notional through physical settlement. Hedge funds--protection sellers--like PAUG because it replicates cash recovery without exposure to the bidding process.
"PAUG takes away the mark-to-market volatility of non-PAUG," said one hedge fund portfolio manager, who added that deals using PAUG to reference CDOs date back several years, but were rare before the ISDA PAUG template. Tourmaline, a hybrid CDO structured by Morgan Stanley and Barclays Capital, managed by Blackrock Financial Management (DW, 8/19) and partially referencing CDOs, used PAUG last year. Several deals are reported to be in the works, but officials declined to comment on them. "It is not yet the market standard," the manager said. "But there is much more liquidity."
Revisions to the PAUG docs on a bespoke basis would not affect the intended asset classes of commercial and residential mortgage-backed securities or the final revised template ISDA published this month.
