Proposed New Rules for Derivatives No Surprise

by: Research Recap

As U.S. Treasury Secretary Timothy Geithner is proposing new “rules of the game,” e.g. much tighter regulation of heretofore unregulated entities, perhaps the least surprising aspect of the plan is the requirement that all derivatives be traded on a regulated exchange.

Regulators and the over-the-counter derivatives industry have been moving in that direction for months now, as participants recognize the need for uniformity and transparency in the wake of the credit-default swaps debacle that brought down insurer American International Group (NYSE: AIG).

The International Swaps and Derivatives Association is currently gearing up for a new framework for trading and clearing North American corporate CDS transactions, set to take effect April 8, according to a report by law firm Paul Weiss.

The new framework is aimed at further streamlining the market and preparing existing and future CDS trades for central clearing.

The ISDA has also published updates to its 2003 rules, referred to as the 2009 Supplement and the Big Bang Protocol, that have three main objectives:

  • The establishment of credit derivatives “determination committees” for five ISDA regions, including the Americas, Japan, non-Japan Asia, Australia-New Zealand and EMEA (Europe, Middle East and Africa), to help resolve disputes.
  • The launch of a standarized CDS auction settlement process across different credit derivatives transactions and credit events.
  • The creation of 60-day credit event and 90-day succession event backstop dates for credit derivatives transactions to close a loophole that currently leaves investors exposed to basis risk.

The new framework for North American CDS that begins April 8 will result in more standardized trading and even a new acronym, “SNACs,” which stands for Standard North American Corporate CDS trades.

Dealers will be required to quote fixed coupons and upfront payments on SNACs and the contracts will have a standard quarterly termination date, similar to those for exchange-traded derivatives, of March, June, September and December, Paul Weiss said.

Legacy corporate CDS in North America will not fall under the new standards.