Landsbanki bonds settled at 1.25% and 0.125%

When CDSs are cash-settled, protection sellers pay protection buyers the par value of the underlying bonds, minus the recovery rate. The results of the Landsbanki auction mean sellers of protection on senior debt will pay 98.75% of par to settle the contracts. Protection-sellers on the bank’s subordinated debt, meanwhile, will pay 99.875%.

The cash-settlement auction process, which is administered by New York-based brokerage Creditex and London-based data provider Markit, is currently undergoing a spate of trials due to roiling global markets. They have caused the default, or technical default, of a host of popular CDS reference entities – including US government-sponsored mortgage lenders Fannie Mae and Freddie Mac, as well as Lehman Brothers and Washington Mutual.

The procedure involves a blind auction in which dealers submit tradable two-way prices for the defaulted underlying bonds. Outliers are stripped from the results, while banks are penalised for overly-aggressive pricing.

The Landsbanki auction involved 14 major dealers and was the first to be held on the bonds of a European CDS reference entity. It was mandated by an International Swaps and Derivatives Association protocol launched on October 27.

Further auctions to cash-settle CDSs linked to the debt of Glitnir and Kaupthing will follow on November 5 and 6, respectively.

See also: Auction sets 57% recovery on Washington Mutual CDS
Lehman recovery rate set at 8.625%
Fannie and Freddie auctions raise questions about CDSs
Auction determines settlement price for Fannie and Freddie
Icelandic banks in default