Isda to publish auction settlement supplement, launches close-out protocol

Participants will be able to sign up to the protocol up until April 7, at which point it will come into effect, incorporating new definitions of credit events and rules for auction settlement into Isda's credit default swap (CDS) settlement protocol.

The supplement will incorporate CDS settlement auction terms, and will also contain terms for the Isda Determinations Committee. Precise definitions on whether a credit event has occurred, whether an auction will be held and whether a particular obligation is deliverable will be included in the supplement, although it remains unclear exactly what these definitions will be.

Concern has mounted recently among portfolio managers following Isda's proposal to remove restructuring as a credit event. Such an amendment would force hedgers to either use a standard contract - but forgo as much as 40% of the regulatory capital relief prescribed by Basel II in doing so - or, alternatively, place hedges using unconventional and less liquid contracts.

Isda is currently in the process of hardwiring into its standard documentation the auction settlement of contracts following a default or credit event of a company referenced by CDSs. In a written statement, Robert Pickel, chief executive of Isda, underlined the commitment of the industry to refine processes surrounding credit derivatives.

On Friday, Isda also launched its 2009 close-out amount protocol. The protocol allows parties to agree in advance on whether they will use the close-out valuation method to value trades in the event of a counterparty default.

Market participants benefited from the methodology following the default of Lehman Brothers last September, Isda stated. It differs from the market quotation technique by giving participants greater flexibility with respect to valuation in illiquid markets.

"The protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances," said Pickel in a written statement.

See also: New single-name CDS sparks hedging worries;
Isda adds buy-side members to board for first time