Buyside and sellside firms spent the beginning of the year arguing over what constitutes restructuring and whether it counts as a credit event (DW, 2/5, 3/19). But in May the International Swaps and Derivatives Association published a supplement to its 1999 definitions of credit derivatives that introduced modified restructuring. However, while U.S.-based institutions accepted it quickly and Asian firms followed soon after, European institutions have not adopted the new language. One market maker estimated only 40% of new contracts in Europe included modified restructuring.
"The concept hasn't really been adopted yet in Europe, because some banks worry if they don't have the old restructuring definition they will not get capital relief," said one market participant. As a result, European names trade under contracts with full restructuring clauses, while U.S. contracts call for modified restructuring.
Scott Eaton, head of integrated credit trading at Deutsche Bank in London, predicted the European market will move more toward a uniform legal backdrop on par with the U.S. "We are seeing a paradigm shift in European credits, where Europe becomes much more like America in the sense of a rational market where corporates are allowed to fail, and we will also see the language move toward the U.S.," he said.
ISDA changed the regulation so that the longest maturity a party could receive as settlement is 30 months following a restructuring date, according to Gordon Boozer, associate in credit derivatives trading atSwiss Re in New York. The decision prevented banks from reaping a big windfall by holding the loans until maturity and recovering them at par, while also collecting on their credit-default swaps. Boozer said changing the deliverables language was a crucial turning point in the continued expansion of the U.S. market because it prevented the banks from delivering an inferior security to the writers of protection. "It just made end users much more comfortable," Boozer said.
The market never looked back, as insurance companies, hedge funds and money management firms found their comfort zone and looked to enter the game. "On the single name side the flows have grown 100%. Everyone is getting involved in credit derivatives from hedge funds to insurance companies," said Alejandro Brockmann, managing director and head of global credit derivatives at Deutsche Bank in New York. In just the last four months, a number of money management and insurance firms, including Hartford Investment Management (DW 11/26), and New Era Life (DW, 10/22) have started getting ready to enter the market.
In Japan, modified restructuring was introduced in October (DW, 10/22). "The objective for trying to get this introduced was to give customers a choice instead of dealers quoting on only their terms," said Kazuyasu Makabe, v.p. of credit trading and co-head of credit sales, trading and research for Japan and Australia at J.P. Morgan in Tokyo. As for as the regional Asian market, Loh Boon Chye, managing director for Asian emerging market credit derivatives at Deutsche Bank in Singapore, believes the market will follow Japan and likely introduce the new language within six months. "Momentum in discussions among players is picking up," said Loh.
