Several domestic European regulators are likely to add credit derivatives to the list of instruments eligible for netting, according to Emmanuelle Sebton, head of risk management at ISDA in London. Regulators, including the French and U.K. authorities, exclude credit derivatives from netting agreements in order to recognize credit risk protection. The argument for excluding credit derivatives is that in the event of the protection buyer entering bankruptcy, which would trigger netting, the bankrupt corporate would lose the credit risk protection it had purchased.
Sebton said, "ISDA believes that the advantages of including the CDS within a netting agreement in other scenarios...far outweigh the costs identified by regulators." The Basel committee and the International Organization of Securities Commissions has formed a working group looking at a trading book review and this issue will be covered by the group, said Sebton. The group will likely find a solution, which will then be adopted by local regulators, she added.
