The group working to standardize a loan-only credit default swap contract has developed a contract and settlement rider designed to minimize counterparty squabbling and keep settlement to T+30. The document has been submitted to the International Swaps and Derivatives Association and emailed to ISDA members for a conference call scheduled for March 3. A loan-only CDS subcommittee of the Loan Syndications and Trading Association is meeting tomorrow to discuss the physical settlement rider. Members of the group working on the document had been optimistic last fall that they would have something prepared to present to ISDA by mid-December, early January (CIN, 11/18), but trying to determine how to settle a trade following a credit event held up the process.
Negotiations of distressed loans in the market often take an extended period of time and can be contentious because a seller of protection must pay par to the buyer of protection in return for an asset that has fallen in price. In order to reduce both the time and frustration of these settlements, the group is attaching a rider to the CDS contract. The attached document is a pre-approved agreement by both the buyer and seller specifying the form of documentation any physical settlement agreement will take.
Howie Shams, managing director in leveraged finance at Credit Suisse, explained that loan settlement documentation negotiations can be hindered when the price of the underlying asset moves significantly. Shams said the group anticipated that settlements would grind to a halt as sellers of protection argued with their counterparties over non-standard documentation points. In order to keep the settlement process moving, the group needed to create a final loan settlement document that the parties could agree on at the time that the CDS contract was executed. "When we considered utilizing the standard LSTA market document, we found that it couldn't handle the inevitable 'credit-specific' modifications that arise from time to time," he explained. "That's why we decided to create the market standard indemnity. With the market standard indemnity, credit specific modifications are implicit and parties can move without delay to physical settlement, confident that they have satisfactory documentation and protections."
Shams expects the LSTA to support the document and specifically the effectiveness of the market standard indemnity. "As these CDS documents migrate to the cash market, buyers will consider whether these documents are adequate and the market will certainly look to the LSTA for guidance."
Elliot Ganz, executive v.p. and general counsel at the LSTA, has been involved in the talks and said the loan-only CDS committee of the LSTA is going to review the proposal, especially the physical settlement rider. When the committee is comfortable with the document it will ask the LSTA to authorize the release of a document supporting the loan-only CDS documentation and supporting the proposition that a loan that settles in the derivatives market under the documentation should be accepted into the cash market on the basis of the market standard indemnity.
During Friday's call, ISDA members can express any concerns or comments they may have with the documents, explained Doug Grossberg, a loan CDS trader at CS. He said he could not predict when a final document would be in place because much will depend upon issues raised during the call. Another trader working on the deal, however, thought a document could be in place as early as the end of March or, at the latest, by the end of April. An ISDA spokeswoman would not comment other than to say it has received a draft of the document and a meeting is scheduled for March.
David Rosen, v.p. and counsel within the legal and compliance office at CS, was optimistic that ISDA's review will be a smooth process because of the comparative diversity of the ad hoc group that presented the draft to ISDA. "We have thought through a wide range of issues and objections in respect of both the derivative aspects and the loan settlement aspects of the product," he said. "We had active participation from the buyside, the sellside and dealers, and attempted to balance the interests of all sides to maximize liquidity in the product."
