The International Swaps and Derivatives Association has set up a credit derivatives market practices committee whose first goal is to sort out the debate over restructuring as a credit event. Although ISDA has tried to help sort out the debate over restructuring with a profusion of committees, task forces, and working groups, this group is different: it's staffed mainly with traders and portfolio managers rather than lawyers, said Blythe Masters, managing director and head of North American structured credit products and asset-backed securities at J.P. Morgan in New York and co-head of the group. The committee also has a deadline it is seeking to meet, which is the beginning of April, in time for the ISDA Annual General Meeting.
The debate centers around how to define restructuring in contracts that include it as a credit event, and what deliverables should be allowed in these contracts. Because longer-dated securities are often deliverable for shorter-dated protection under the standard quoted terms of the ISDA credit default swap contract with restructuring, the seller of protection could end up with a different sort of credit exposure than what it bargained for in the event of a loan restructuring (DW, 12/24). The group will work to alter the language of the restructuring definition to the satisfaction of all parties.
The committee is not aiming to determine whether parties should select restructuring in credit default swaps, as that is a choice parties make on a case-by-case basis. Instead it aims to remove confusion regarding using restructuring, which according to Masters should narrow the gap between the prices for contracts that use restructuring and contracts that don't. Contracts with restructuring currently cost about 10-15% more than contracts that don't, a gap that could shrink to 2-5%.
According to Masters, lawyers involved in this discussion have resolved some issues with respect to possible wording for the new contracts, but need the help of traders and portfolio managers to determine proper market practice.
The committee will continue to meet after restructuring has been resolved, and will look to address issues such as burnishing the tarnished image of credit derivatives. Some media outlets have suggested that credit default swaps are not legally enforceable, a misperception the group is looking to clear up.
