CDS changes to enhance liquidity, standardization

NEW YORK, April 7 (Reuters) - Changes will be made on Wednesday in the way North American credit default swaps are traded, with the aim of improving liquidity and standardizing contracts in the $27 trillion market.

Pricing conventions and start and end dates for trades have been standardized, while procedures designed to improve trade settlement when borrowers default are included in the changes, known in the industry as the "Big Bang."

Some analysts and market participants note the extent of the changes could create confusion among some clients, and investors that have not signed up for the changes are likely to find it harder to enter transactions.

Most are supportive of the changes, however.

Standardization is needed for the contracts to be cleared through central clearinghouses, which are viewed as key to removing the systemic risks posed by the failure of a large CDS counterparty.

"I think it's going to be a good thing, everything contained in the protocol is designed to make single name CDS trades effective on a central clearing counterparty. Everything in there is designed to mutualize the counterparty risk," said Brian Yelvington, analyst at independent research firm CreditSights.

The Intercontinental Exchange (ICE.N) and CME Group Inc (CME.O), which runs the Chicago Mercantile Exchange, are the two main contenders in the race to clear the majority of U.S. trades.

Standardizing trades to establish start and end dates will also allow CDS participants offset trades more effectively, and remove a risk that has in recent months made it complicated for investors to exit trades.

Currently, trades are effective based on the day they are entered into, which makes it complicated to fully hedge a contract with an offsetting trade.

For example, if an investor had sold protection on a company a year ago, and sought to hedge the position by buying protection on the same company today, the investor would still be exposed to paying for any default that occurs in the year that was not hedged.

This is a concern because when there is an event that triggers the paying out of a CDS contract, occasionally it is not determined to be a default until some time after the actual event.

The standardization could also speed up efforts to reduce gross CDS volumes by eliminating offsetting trades, said Tom Price, global head of credit at data provider Markit.

Gross CDS volumes have fallen to around $27 trillion from more than $60 trillion last year as dealers tore up offsetting trades. With the enhanced standardization, volumes could drop below $10 trillion, Price said at a press briefing on Tuesday.

Investors that have not yet signed up for the new trading conventions, however, may find dealers refuse to trade with them.

"The only thing that could be a little erratic is getting everyone to adhere to the protocol," said Yelvington. "At a certain point, the availability of dealer provided liquidity will solve this."

New procedures in pricing trades could also spark some short term confusion.

The changes "are sure to have dealers and end-users a little frantic over the next few days," Tim Backshall, chief strategist at research firm Credit Derivatives Research said in a report on Tuesday.

(Reporting by Karen Brettell; Editing by Chizu Nomiyama)