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Corrigan: Cash Settlement a CDS Missing Link
May 28, 2007
During the
Federal Reserve Bank of Atlanta's conference on credit derivatives
two weeks ago in Sea Island, Ga., Corrigan said that the policy
group's prescriptions for reducing CDS confirmation backlogs and
bringing order to assignments or novations of the instruments have
been successfully met. But a uniform cash settlement process for
actual defaults, or credit events, has yet to be fully
realized.
Speaking to reporters, Corrigan said that such a cash settlement mechanism is "not fully institutionalized," and it needs to be in place "sooner rather than later."
Over the last two years, Corrigan estimated, there have been eight to ten reference-entity credit defaults--auto parts companies Collins & Aikman and Delphi Corp. and the Delta and Northwest airline bankruptcies among them--that prompted a cash settlement procedure. These events posed varying degrees of difficulty, according to a paper presented at the conference by David Mengle, head of research at the International Swaps & Derivatives Association (ISDA), which has proposed a protocol approach for managing the multilateral complexities of large-scale defaults.
In Corrigan's view, "We have successfully muscled through the settlement process in the aftermath of defaults and gained a great deal of experience in how to manage these situations." But he is still looking for a "single ISDA-type protocol" that puts a uniform and fully institutionalized cash settlement mechanism in place for future eventualities. He said the possibility of a "large-scale default and multiple defaults" is the "great imponderable" that could make it far more difficult to just "muscle through" on an ad hoc basis.
Corrigan, who in 1993 ended a 25-year career in the Federal Reserve System, where he rose to president of the Federal Reserve Bank of New York, and now is co-chairman of Goldman Sachs' firmwide risk management committee, reiterated his belief in public- and private-sector cooperation as a means to risk-mitigating solutions. He has called the Counterparty Risk Management Policy Group's 2005 CDS report and the industry's response to it "a high-water mark in my career."
ISDA, though, has its eye on the cash settlement ball--having been part of earlier "muscling through" solutions. Last Sept. 27, coinciding with a review at the New York Fed of remedial efforts to that point by major CDS dealers, ISDA issued a statement committing to carry its support of credit-derivatives improvements into the cash settlement realm. After the Dura Automotive Systems bankruptcy filing about a month later, ISDA's protocol, which originally was applied to credit derivative index transactions, was used to settle single-name CDS transactions, said an ISDA spokesperson in New York.
The association said in September that its new cash settlement mechanism "will be utilized for settlement of the earliest credit event under the 2003 ISDA Credit Derivatives Definitions and corresponding index documentation. Its effectiveness will be assessed on completion of the settlement process for affected trades. The cash settlement mechanism will ultimately be incorporated into a new set of credit derivatives definitions, which will also address dispute resolution for credit derivative transactions, and which are anticipated for publication in 2007."
