Dealers in European loan-only credit default swaps are leaning toward a contract that would allow for trades in both cancelable and non-cancelable forms in the near term. Several dealers are still optimistic, however, that even if the initial contract offers both options, it will move exclusively to non-cancelable in the future.
As first reported on CIN's Web site last week, dealers continue to meet and a few participants said there are still a number of items under discussion and it's too early to comment on what the final form will look like. But he added that it appears the contract will allow dealers to trade in both forms. This will give participants the option to choose whether they want cancelable or non-cancelable documentation. Two European dealers anticipate the contract will be finalized in early 2007.
In a cancelable document, if the loan gets refinanced and goes away, the trade also goes away. In a non-cancelable document, if the loan goes away, the trade stays. The banks had initially been trading on a document that allowed for cancelability, but a number of banks wanted to develop a contract that more closely resembles the U.S. version that trades with non-cancelable language. The International Swaps and Derivatives Association had been working with banks to develop a European confirm that would include a non-cancelable provision (CIN, 11/13). But a few dealers think it will ultimately be all non-cancellable. "I think once [dealers] start trading on a non-cancelable document, it will kill the other ways, just like it did in the U.S.," one trader said. A call to ISDA was not returned by press time.
Some U.S. dealers were concerned there could be confusion if both options were offered and trades were being done on different contracts. But European dealers stressed that the U.S. market and the European market are so different they could not use the same documents even if they wanted to. "We have different settlements because we operate with a [Loan Market Association] document settlement and they operate with a [Loan Syndication and Trading Association] settlement," one European trader said. "We have restructuring, (the U.S. does not); we are never going to get to a contract that is the same as in the U.S."
Another issue is that some dealers thought differing documentation would limit cross-border deals. While a few have been done, it is still not common. And while one U.S. dealer familiar with the European market thought this could increase, a European dealer said such a trade would be risky because there is going to be such a mismatch between documents.
Two weeks ago the International Association of Credit Portfolio Managers sent a letter to ISDA expressing its support of the European cancellable LCDS contract (11/13). One European dealer thought the group should be satisfied the document will offer both options. He said European dealers will not be responding to the letter.
Marcia Banks, IACPM associate director, who sent the email with the letter, said the letter was intended to "provide our viewpoint that we do support a cancelability feature." IACPM would also like to see the U.S. documentation include a cancelable option.
One European trader said volume has been great, with trades becoming more equally balanced between index trades and single-name trades. The index launched a few weeks ago. He said dealers are now focused on whether the contract should broaden the number of deliverables beyond the reference obligation to include all secured debt.
