* First change in 10 yrs
* Aim to bolster sovereign CDS
* Restructuring 'events' seen as key weakness
* Changes to financials' CDS also looming
(Adds additional background)
By Christopher Whittall
LONDON, March 5 (IFR) - The International Swaps and
Derivatives Association on Tuesday proposed the first major
overhaul of credit default swaps in a decade, looking to fix
perceived flaws in the CDS market in the wake of Greece's
troubled restructuring and the sovereign debt crisis.
The primary change concerns how to make sure that those who
purchase sovereign CDS are adequately compensated, after it
became clear that some who bought protection on Greece might not
have received a sufficient payout.
CDS have often drawn the ire of policymakers since the 2008
financial crisis, which in part was driven by the bubble in
structured finance products. Traders say that an EU-wide ban on
speculative sovereign CDS that was imposed in November has
halved sovereign CDS volumes overall.
"This is part of ongoing work: to look at the CDS
definitions and see what changes might need to be made in light
of the events of the last 10 years, and more recently the
financial crisis and European sovereign debt crisis," Mark New,
assistant general counsel at ISDA, told IFR.
GREECE IS THE WORD
The biggest flaw in the current set-up concerns
restructuring credit events in which a debt exchange is carried
out before any CDS auction is held.
In the most high-profile such example - Greece's EUR100bn
restructuring last year - the payout on CDS following the
auction was actually in line with bondholder losses.
But credit experts said this was a fluke, because at the
time of the auction, the new bonds happened to be trading at the
same depressed level (around 20) as where the old bonds had been
Otherwise, those holding CDS contracts might have taken a
Under the new proposals, an asset package of securities
(rather than just bonds or loans) could be delivered into the
sovereign CDS auctions, which help determine CDS payouts.
In Greece, for example, this would have meant permitting the
GDP warrants that investors received in the debt exchange along
with their new bonds to be delivered into the CDS auction - an
asset package that should have ensured a fair payout on CDS.
New said there were three other proposed changes aimed at
fixing technical glitches with CDS contracts: one regarding
succession events, another on qualified guarantees and one on
the list of deliverable obligations for liquid CDS names.
It is not clear when ISDA, an industry group, would be able
to finalise the changes to CDS contracts will be finalised.
"There is no concrete time frame, but there is still a lot
of work to do and any feedback on the proposals would have to be
incorporated into any re-drafting of the credit definitions,"
And while ISDA vowed to implement a wider overhaul of CDS
contracts after the Greece credit event, the new proposals only
concern sovereigns and not financials.
The recent case of Dutch bank SNS Reaal has illustrated the
shortcomings of the restructuring credit event are also apparent
in financial CDS, after the Dutch government expropriated all of
the lender's subordinated debt in February before a CDS auction
could be held.
"The [ISDA working] group has not yet considered a proposal
for asset packages on financials, but we expect that to happen
soon," said New.
"Having seen Greece, we have more data on sovereign
restructurings and what an asset package may look like. A
proposal for financials could take a bit longer to put together
- Basel III has not been implemented in the US or Europe and so
there is limited information around what bail-ins may look
CDS notionals have remained on a downward trend since the
market's peak of USD58trn notional outstanding at the end of
2007, hitting a new low of USD27trn at the end on June 2012,
according to the Bank for International Settlements.
(Reporting By Christopher Whittall; Editing by Alex Chambers
and Marc Carnegie)