A debate surrounding what should constitute a credit event is delaying the International Swaps and Derivatives Association's standard document for credit derivatives referenced to asset-backed securities. The argument hinges on whether an asset-backed security that stops paying its noteholders because of a lack of funds should be counted as defaulted.
Some ABS participants want the documents to facilitate a liquid traded market while others want to use it to hedge or invest in ABS in the same way as they would in the true-sale market. ISDA has been preparing two templates, one which includes a pay-as-you-go event and another that tries to replicate the true-sale ABS market. It is now thinking of collapsing the two confirmation templates into one. ISDA will propose the idea to a working group for the project in January.
Pay-as-you-go settlement has proven beneficial to monolines because it enables them to carry on their wrapping business in synthetic form, while cash settlement is designed for the inter-dealer market, explained Lary Stromfeld, a partner in the capital markets department of Cadwalader, Wickersham & Taft in New York. To the extent they are going to be selling credit protection in the derivatives market, monolines generally prefer to have settlement payments occurring over time. "It helps their liquidity," Stromfeld said. Dealers, on the other hand, generally prefer to just settle up on a mark-to-market basis on both the buy- and sell-side, he said.
While the two approaches are servicing different bases, there is enough overlap between them that ISDA thinks it may be better to combine the two templates, said Kimberly Summe, general counsel at ISDA in New York.