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2014 Credit Derivatives Definitions Protocol out of the gates

On 21 August 2014, ISDA published the 2014 ISDA Credit Derivatives Definitions Protocol. Members and non-members can adhere by 12 September 2014. Citigroup is the first entity to adhere to the protocol.

The protocol should enable the adhering parties to effectively transition to the new 2014 ISDA Credit Derivatives Definitions, published earlier this year and intended to be used generally from 22 September 2014. The 2014 definitions represent a major overhaul compared to the updated 2003 definitions as currently used generally in the market.

In order to provide for an immediate implementation of the 2014 definitions while leaving enough time to update the legal templates, the transactions covered by the protocol and entered into between the adhering parties up to 18 September 2015 will be deemed to incorporate the new definitions.

The types of transactions covered by the protocol are:

  • Covered  Index  Transactions  (including  CDX  and  iTraxx  Tranched  and  Untranched)
  • Covered Swaption Transactions (single name and portfolio)
  • Covered  Non-Swaption  Transactions  (e.g.  Single  name,  Fixed  Recovery,  Recovery Lock, Nth to default, Bespoke Portfolio Transactions)

Certain types of credit derivative transactions are excluded from the scope of the protocol, including:

  • Loan Only transactions
  • U.S. Municipal type transactions
  • Credit derivative transactions on asset backed securities

In addition, ISDA published a list of certain excluded reference entities  due to the material impact that the new definitions might have on the terms and value of credit derivatives. The list contains 201 sovereign, financial and corporate entities.  The adhering parties also have the possibility to bilaterally and separately exclude certain transactions from the scope of the protocol on a case-by-case basis.

The legacy definitions and the 2014 definitions are expected to coexist for a time. In certain circumstances, the 2003 definitions will remain relevant in order to close out or hedge positions excluded by the protocol.  Basis risk will certainly arise from the friction between transactions linked to legacy definitions instead of the new ones. For instance, issues might arise for a transaction referencing the 2003 definitions which is hedged with a transaction referencing the 2014 definitions.

The 2014 definitions are meant to address the numerous shortcomings coming from the inability of the legacy definitions to impose standard characteristics to credit derivatives and anticipate ingenious changes brought to the reference obligations of a reference entity, including sovereign ones. Distinctions are made between subordinated and senior debt, where appropriate, while the concept of standard reference obligation (SRO) provides a robust framework for commonly traded reference entities.  Unless stated otherwise, credit derivatives linked to this select group of reference entities will always point out to a generic reference obligation and seniority level.

Lo and behold: doomsday scenario of a break-up of the Eurozone is already taken care of by the 2014 definitions.

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