Pressure from regulators and the looming likelihood of a big auto default is giving momentum to a credit-default swap cash settlement draft. Operations and legal teams have not yet signed off, however, so last week's International Swaps and Derivatives Association's annual general meeting in Singapore was abuzz with talk of the double-edged sword: risking untested back-office systems by speeding ahead, or incurring Federal Reserve wrath by transferring operational resources away from improving confirms--last year's hot potato--and onto developing cash settlement.
ISDA put to delegates a proposal to cash settle all index, tranche and single-name trades over USD100 million through a netting process dependant on dealers electronically submitting trade and counterparty details to a third party. The draft is ambitious because previously the association has only handled one-off index CDS settlements. It also complicates the task because it looks to tackle credit risk by limiting netting to counterparties which already have trade relationships.
Kimberly Summe, ISDA general counsel, admitted there are a host of hurdles to cash settlement and called on delegates for help answering questions posed by the draft. There was little immediate response as lawyers, dealers and back office staffers digested Summe's suggestions and questions. A significant potential worry she highlighted is the possibility the organization called on to process and net the trades could be seen as an exchange or a clearing system--which may create more regulatory obstacles.
A key concern of delegates also is that the proposed system may further separate the small fish from the big, with small players being forced to shell out for expensive access to an over-the-counter settlement provider and less-sophisticated users potentially being put off altogether. All delegates, however, agreed solving the cash settlement problem is this year's highest priority for the trade association. "This has to be the main focus of the industry," said Mike Pohly, managing director and head of North American credit trading at Morgan Stanley.