The credit market was gearing up to test out cash settlement of credit derivative indices last week. If an auction to determine the recovery value of outstanding index-linked credit-default swaps referencing Delphi Corp. runs smoothly, dealers said, it could make cash settlement the industry standard for resolving future credit events affecting the indices. Officials predicted the next CDX index roll in March will likely include procedures for cash settlement.
"Physical settlement made sense until the development of index trading," said David Mengle, head of research at the International Swaps and Derivatives Association, at an ISDA seminar on credit derivatives last week. The popularity of index trading has allowed more market participants to reference bonds than actually hold them, making physical settlement impossible for index players.
The Delphi auction, scheduled for last Friday after DW went to press, follows similar procedures established after the bankruptcy filings by Collins & Aikman, Delta and Northwest. Five hundred seventy eight firms, including all the major dealers, many hedge funds and other counterparties, signed up to ISDA's amended Delphi CDS Index Protocol for participation in the auction, which will be administered by Markit and Creditex.
