Credit-default swaps market leaders will meet this week in New York and London to discuss changes to the contracts in what may be the biggest revisions since 2009, according to people familiar with the situation.
Possible changes to standard contracts, which are governed by the International Swaps and Derivatives Association, include how debt-for-equity exchanges would be treated after a bankruptcy, specifying that credit swaps only cover losses from defaults that occur after their purchase, and clarifying how the date of a so-called credit event is determined, said the people, who asked not to be named because the discussions are private.
ISDA’s credit steering committee is considering the changes after Greece’s debt restructuring posed the biggest test for the $26.5 trillion credit swaps market since banks including JPMorgan Chase & Co. created it more than a decade ago. ISDA, based in New York, last overhauled the derivatives three years ago in the so-called Big Bang and Small Bang protocols that created a new set of standards to increase transparency and confidence in the market.
The May 11 meeting of the credit steering committee will begin the formal process of revamping the contracts by collecting proposed changes from the members, the people said. Any changes must be approved by users of the existing contracts because the changes will apply to those trades already executed, they said. More than 2,000 banks, hedge funds and other asset managers in the credit-swaps market in 2009 agreed to adopt the ‘Big Bang’ protocol.
One possible change includes fixing a flaw in the contracts that can leave buyers with only part of their losses covered from a sovereign debt restructuring, Steven Kennedy, an ISDA spokesman in New York, said earlier this week.
Credit swaps payouts after a government debt exchange would be tied to the ratio of the face value of the new bonds to the old bonds. That would seek to prevent scenarios where payments are limited to swaps buyers because the new bonds are trading close to par, a concern of market participants after Greece undertook the biggest sovereign-debt restructuring in history. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.
The restructuring change was the subject of a proposal by Stanford professor Darrell Duffie and student Mohit Thukral in a May 3 report.
“The proposal makes sense, and these very issues have, in fact, been under consideration by ISDA for some time,” Kennedy said in a May 7 e-mailed statement. “It was initially raised as a formal question during the determinations-committee deliberations on the Greek credit event.”
Kennedy declined to comment on this week’s meeting.
Another proposal the credit steering committee may consider is how to deal with a company that undergoes a debt-for-equity swap after a credit event has occurred, the people said. The concern arose in the bankruptcy of CIT Group Inc. when the commercial lender proposed to exchange its debt for equity before the credit swaps settlement date, one of the people said. Because only bonds and loans are deliverable under the current standard swaps contract, that left the possibility of having no debt with which to settle the contracts.
The determinations committee, a group of 15 dealers and money managers that govern the market, said in the CIT case that the debt that could be swapped to equity was allowed to be delivered; the aim now is to codify that procedure in the contract rules, one of the people said.
Another possible change is adding language that makes it clear that credit swaps bought after a credit event don’t apply to past defaults, the people said.