ISDA's new protocol will allow cash settlement of credit derivatives

By Angela McDaniels

Seattle, Sept. 27 - The International Swaps and Derivatives Association launched a new protocol on Wednesday that permits cash settlement of single-name, index, tranche and certain other plain vanilla credit derivative transactions, according to an association news release.

"ISDA's new cash settlement protocol is another major step in streamlining market and operational processes for privately negotiated derivatives," chief executive officer Robert Pickel said in the release.

The new cash settlement mechanism will be used for settlement of the earliest credit event under the 2003 ISDA Credit Derivatives Definitions and corresponding index documentation.

Its effectiveness will be assessed upon completion of the settlement process for affected trades, and the association said the mechanism will ultimately be incorporated into a new set of Credit Derivative Definitions, which the association said will also address dispute resolution for credit derivative transactions. The definitions are anticipated for publication in 2007.

Speeding back office

The cash settlement mechanism is one of several initiatives the New York financial trade association is pursuing in order to improve operational efficiencies. Another major area of focus is improving credit derivatives processing through initiatives in operations and documentation. Since Sept. 30, 2005, backlogs of outstanding confirmations have fallen by over 80% on average, the association said.

"ISDA will continue to provide the forum for identifying and prioritizing areas of focus for its members. To effect these changes, we have focused the industry on standardization, automation, increased specialist staffing and close monitoring of industry metrics, as well as the practice of bilateral 'lock-ins' to reduce confirmations work in hand between parties," Pickel said in the release.

Pickel's remarks were made against the backdrop of a meeting of major financial market regulators with a group of 16 banks on Wednesday to review the industry's progress on operational issues related to credit derivatives and other types of derivatives. The Federal Reserve Bank of New York hosted the meeting.

According to a Federal Reserve Bank news release, in the last 12 months the major firms have:

• Ended the market practice of assigning trades without obtaining prior consent of the counterparties;

• Reduced the number of all confirmations outstanding by 70% and confirmations outstanding for more than 30 days by 85%;

• Doubled the share of trades that are confirmed on an electronic platform to 80% of total trade volume; and

• Agreed upon a protocol for the settlement of a credit event.

The bank emphasized the importance of sustained progress toward a more automated post-trade processing environment where the vast majority of trades are processed electronically and where there are strong risk mitigants for more complex trades.

"We also believe it is important to see the participants' robust adoption of the newly created trade information warehouse. Finally, we look forward to seeing the industry improve the automation and standardization of over-the-counter equity derivatives trading and reduce the current levels of unconfirmed trades," the bank said in its release.

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