The Financial Services Authority has amended its rules on first-to-default baskets to mean that protection sellers will have to hold less regulatory capital against some first-to-default baskets. Bankers said this could be a huge boon for the credit derivatives market. "If they are in the U.K., protection sellers will hold less capital against these instruments, so this increases the potential market for them," said Claude Brown, partner at Clifford Chance in London.
The main benefit is for funded credit derivatives because they can be classified as a 'qualified debt instrument.' Under the new rules the protection seller in a first-to-default basket--structured as an investment-grade credit-linked note--only has to hold regulatory capital against the weakest name. Under the old rules the seller would have to put aside a dollar for each dollar of exposure, explained Patrick Clancy, counsel at Shearman & Sterling in London.
The FSA has also clarified the rules for baskets in which the protection seller is exposed to multiple defaults, known as n-to-default baskets. Brown explained that in a second-to-default basket referenced to six corporates the seller would have to hold 40% of the notional value of the basket as regulatory capital. The FSA will allow the seller to exclude one name and then all the others are 100% risk weighted, which in the case of investment-grade corporates means the seller has to hold 8% of capital against them.
