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ISDA Puts ABS Credit Events On The Agenda

29 Feb 2004

The International Swaps and Derivatives Association is planning to ask its members whether it should write a standard set of definitions for credit events in credit derivatives referenced to asset-backed securities.

The International Swaps and Derivatives Association is planning to ask its members whether it should write a standard set of definitions for credit events in credit derivatives referenced to asset-backed securities. The move follows a huge increase in the number of CDOs referenced to ABS, which now account for around half of new issues, according to rating agencies. Louise Marshall, policy director at ISDA in New York, said it will discuss the issue at this month's credit derivatives market practice committee meeting.

At the moment each bank selects which credit events should be considered triggers on a deal-by-deal basis and these can vary significantly, according to Paul Mazataud, a managing director in the CDO group at Moody's Investors Service in Paris. The major difference in the documents is how they are written, rather that what they say, and this should make them easier to standardize. Mazataud thinks investors would see the main benefit because they could compare deals from different banks without having to get bogged down in the fine print. Moody's, however, has already done the heavy lifting in terms of understanding each bank's documents so this would not be a huge timesaver for the rating agency.

Richard Gambel, head of synthetic CDOs at Fitch Ratings in London, said, "Standardization is always desirable." He pointed out, however, that each type of ABS is different and it would be hard to write one set of documents, covering the whole asset class.

The maturity of the underlying might also prove an obstacle to creating a standard set of documents, noted Gambel. When the credit derivative and the underlying pool have the same maturity, a straight-forward 'failure-to-pay' credit event is suitable, but if the underlying pool has a much longer maturity, say 25-years, then the documents are written to capture potential events. This is because most defaults occur near the end of a transaction and the protection buyer would not be mitigating much risk through a failure-to-pay credit event on the first five years of a 25-year mortgage-backed security.

 

29 Feb 2004