ISDA adds credit derivatives supplement to clarify mergers, bankruptcy

New York, Nov. 28 - The International Swaps and Derivatives Association announced a new supplement to its 1999 ISDA Credit Derivatives Definitions, intended to make clear what the successor is in the event of a merger, consolidation or transfer and to amend the language defining bankruptcy. Also included is a change so that switching payments to a new currency will not cause a credit event in some circumstances.

The supplement follows work by the derivatives trade group's Credit Market Practice Committee.

For the definition on successors, ISDA replaced the phrase "all or substantially all" with a numerical threshold. If an issuer assumes 75% or more of the bonds and loans of the original reference entity then the sole successor becomes the reference.

ISDA said it examined the successor definition after issues raised by the demerger of National Power, a U.K. utility that was the reference on a number of credit default swaps.

"This resulted in debate as to the identity of the Reference Entity following the demerger," ISDA said in its commentary on the new documents.

Where the 75% test is not met, ISDA said there are two options: follow the original reference credit or divide the transaction into a series of single-name default swaps. Because the first may not in some circumstances be practical or make commercial sense, ISDA recommends the second path. Consequently, the association advises that each entity succeeding to 25% or more of the bonds and loans of the original reference become a reference in a new default swap.

If this 25% threshold is not reached, ISDA recommends keeping the original reference if it continues to exist. If it does not, then the entity taking on the greatest percentage of bonds and loans becomes the new reference. Where two credits take on the same percentage, ISDA says the new reference is the one taking on the greatest percentage of obligations.

For bankruptcy, the definitions are amended so that only admission in a judicial, regulatory or administrative proceeding or filing constitutes a credit event trigger.

ISDA said questions had been raised about the original definition, particularly by rating agencies.

Concern centered on two parts of the wording, ISDA said.

One section - which ISDA is not deleting - defined a bankruptcy credit event as actions by the reference credit "in furtherance of, or indicating its consent to, approval of, or

acquiescence in" a bankruptcy action. This, ISDA was told, could result in a bankruptcy credit event and settlement of the derivative even if an issuer only discusses a bankruptcy filing with counsel without taking any further action.

The other section is changed to exclude comments by an issuer that is unable to make payments or insolvent unless they are made in a judicial, regulatory or administrative proceeding or filing.

"Admissions made in these contexts were seen to be a more likely indicator of the occurrence of a Credit Event," ISDA commented.

Other statements, even if in writing are now excluded, ISDA said, taking into account comments that an issuer could subsequently find other sources of liquidity to make payments.

"Thus, a statement made to regulators was seen to be qualitatively different from a statement made to a creditor or other third party at a time when no payments are due," ISDA remarked.

As far as currencies of payment are concerned, ISDA amended its definition so that a change in currency does not result in a credit restructuring event as long as it is to the currency of a G7 or OECD member country with a local currency long-term debt rating of at least AAA from Standard and Poor's, Aaa from Moody's Investor Services or AAA from Fitch.

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