London-based data provider Markit is postponing the roll of its LCDX index of 100 North American loan credit default swaps (LCDSs) until negotiations for a new single-name US LCDS contract are finished.The LCDX has semi-annual roll dates in April and October, when a new index is launched to replace the old series. But on October 3, Markit announced a roll to series 11 of the index would be postponed while dealers finalise new single-name LCDS documentation.
These negotiations are continuing, although the International Swaps and Derivatives Association suggested that dealers had recently been distracted by events occurring elsewhere in the market.
“Industry developments have called for other priorities to be handled ahead of a new document for non-cancellable LCDS, but it is on Isda’s radar to address [this] in the very near term,” a spokesperson said.
Five credit event auctions aimed at setting recovery values for credit default swaps (CDSs) on firms in technical default are taking place this month – an unprecedented number.
Dealers have long been divided on whether single-name LCDSs should be open to cancellation by protection buyers. Currently, US LCDSs can be cancelled by protection buyers if underlying loans are repaid and no replacement loan linked to the same entity can be found after 30 days. For banks, this feature makes them a better hedge for underlying loans, as it essentially gives them a call option on the contracts in circumstances where the hedged assets no longer exist.
However, it also makes them more difficult to handle for protection sellers, who may not have advance knowledge of a cancellation. This led some dealers in the US to lobby for talks on a new non-cancellable single-name LCDS, which they argue will create greater liquidity in the market.
The issue of cancellability has also been controversial in Europe, where a compromise was reached in July 2007 allowing both cancellable and non-cancellable standard single-name LCDSs to be traded.
Markit said the language and characteristics of the new non-cancellable US LCDS contract would be integrated into the LCDX index “if and when” market participants agree.
Despite the current market crisis, Isda published revised documentation for European single-name and index LCDSs on October 3. The new European contracts incorporate an auction process to set recovery values for defaulted LCDSs, which is similar to that presently used for CDS and US LCDS contracts.
The procedure faces its biggest ever test this month, as auctions to cash-settle CDSs on government-backed mortgage lenders Fannie Mae and Freddie Mac, Lehman Brothers and Washington Mutual loom. On October 2, an auction to cash-settle CDS linked to Quebec-based forest products company Tembec put a final value of 83% on the defaulted contracts.
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