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IACPM Pushes For European Cancelable LCDS Document

The International Association of Credit Portfolio Managers last Wednesday sent a letter to the International Swaps and Derivatives Association expressing its support of the European cancellable loan-only credit default swap contract, setting up a faceoff over documentation.

The International Association of Credit Portfolio Managers last Wednesday sent a letter to the International Swaps and Derivatives Association expressing its support of the European cancellable loan-only credit default swap contract, setting up a faceoff over documentation. ISDA is working on a version that more closely resembles the U.S. document that has a non-cancelable provision, meaning even if the loan is called, the trade stays in place. The issue had been discussed in both the U.S. and Europe and the underlying feeling in Europe had been that traders would use the call option documentation now, but move to the U.S. document in the future.

In Wednesday's email Marcia Banks, associate director of the IACPM, writes that "the cancelability provisions in current LCDS documentation are an area of concern." The bullet point statement approved by the IACPM board of directors and endorsed by member firms says IACPM supports "the cancelable LCDS contract currently in use in Europe and the inclusion of standard cancelability provisions, as an option, under U.S. LCDS documentation." A call to Banks was not returned by press time, nor was a call to Keith Ho, vice chairperson. Ivan Marcotte, chairperson, was out of the office and could not be reached. ISDA has tried to make contact with the IACPM, but Kimberly Summe, general counsel of ISDA, declined to comment about the letter.

The concern among dealers is that if the document has the cancelability provision, there will not be a standard document. "If you have two different standards there is never going to be a unified market, there is not going to be good liquidity," one dealer said. "The goal in the U.S. was to come up with one that is standard." There is not a lot of cross border trades going on right now, though there have been some Europeans doing U.S. LCDs and some U.S. buysiders trading on the European side, but the general rule has been that the markets are separate.

It is unclear if this letter suggests that member firms will not use the ISDA document or rather if the IACPM is just trying to pressure ISDA into keeping the cancelable provision. Members in Europe had initially been trading on a Morgan Stanley document that allowed for cancelability, but a number of banks had been at an impasse because some wanted to use the European documentation, while others wanted to develop a contract that more closely resembles the U.S. version. ISDA has been working with the banks to develop a European confirm that will include a non-cancelable provision.

"I don't think they are prohibiting members [from participating] in the non-cancelable market, but they are trying to get together and pressure [ISDA] not to change the call feature," one U.S. dealer said. "I care that they came out with something [because] they are not thinking through the issue of why the call option rule will not promote liquidity. Including that call option will not make people want to trade, which is what is shortsighted about it."

In the letter the IAPCM writes that because loans are frequently repaid or refinanced with other loans, it is not certain what the new obligation/entity structure will be. "[The] lack of cancelability introduces the possibility of a mismatch between the hedge and the underlying loan asset when the asset is refinanced, which can increase overall hedging costs."

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