* Choice of 4 coupons -- 25, 100, 500 and 1,000 bps
* Standardised settlement process to come by end-July
* Dealers expected to pick one coupon type for each name
(Adds details, background, byline)
By Jane Baird
LONDON, June 8 New trading conventions on
European credit default swaps will come into action on June 22,
traders and Markit officials said on Monday, in further efforts
to standardise contracts and prepare for a central clearing
The new convention will mean that CDS on individual
corporate borrowers will be priced based on fixed coupons,
similar to the way that the Markit iTraxx European indexes
There will be a choice of four fixed coupons for new trades
-- 25 basis points, 100 basis points, 500 basis points and
1,000 basis points, Markit officials said at an industry
conference. The latter is not expected to be traded heavily.
The changes are aimed at standardising credit derivatives
contracts to help dealers net their positions and cut the
number of outstanding contracts in a process known as
compression, and also to help a central clearing house balance
its different positions to reduce risk.
Under the current system, single-name CDS contracts trade
at a par spread -- the level that makes the contract's value at
the outset equal to zero for both the buyer and seller of
The new convention will instead fix a coupon at the outset
of a contract. For example, a CDS now quoted at 150 basis
points would be quoted with a coupon of 100 basis points plus
an additional upfront payment equal to the 50 basis points.
The fixed coupon and variable price makes it easier for the
dealer or central counterparty to match trades on the same
underlying name, even though they are executed at different
times and at different spreads.
The U.S. market took the lead in adopting the new trading
conventions in early April but with only two available coupon
options at 100 and 500 basis points.
The European approach will offer four coupons for new
trades and two other coupon options to remake existing trades,
traders said. The two other coupons are 300 and 750 basis
points, they said.
The greater the number of coupon options, the less
potential for standardisation, however.
Traders said that they expect dealers will quickly settle
on one preferred coupon level for each corporate name to head
off the potential for arbitrage between different coupon
The new trading regime officially becomes effective when
single-name contracts are scheduled to roll over on June 20, a
Saturday, and will start to impact trading two days later.
In the United States, the new pricing was introduced at the
same time as a move to standardise the auction process for
defaults and include it in the wording of CDS contracts, known
as the "Big Bang."
Europe has not yet come up with its equivalent changes to
the settlement process for defaults.
One big difference is that while the U.S. CDS contracts
eliminated restructuring as a potential credit event, Europe's
standardised settlement process will continue to include
restructuring as a potential trigger for payment under CDS
The International Swaps and Derivatives Association is due
to publish the new European protocol, being called the "Small
Bang," next week, with the aim to have it adopted by the
industry by end-July, Markit officials said.
That would be just in time to meet the industry commitment
to European regulators to begin using central clearing houses
by July 31.
(Additional reporting by Natalie Harrison)