The firms have outsourced the legal work to Allen & Overy, which will establish the relationship between the REs and ROs at the time the latter, typically the RE's longest-dated senior unsecured bond, was issued. This information is usually available from the bond prospectus. Allen & Overy is also building the database, working on the initial data scrub and getting its procedures in place to provide monthly updates.
The next step is more difficult: updating the information every month. This requires Allen & Overy to check that the status of the reference entities and obligations have not changed - typically by reviewing incorporation documents filed with the government bodies like the state registrars in the US.
Since the dealers expect the project to eventually cover several thousand reference entities, which are domiciled in dozens of countries, this will prove a time-consuming and expensive process.
The project will also tackle loans - which are trickier because there is no or little public disclosure of their terms - at a later date.
Derek Smith, managing director of credit derivatives at Goldman in New York, said dealers face a two-fold problem. "We need to be confident we are trading on the entities we think we are trading on, so we need a master list of reference entities and reference obligations," he said. "But we also need to understand the relationship between the two." For example, a bond issued by one company could be guaranteed by a related entity or a third party, so a dealer writing or buying protection on a reference entity needs to understand its capital structure.
While the cost will initially be shared among the three participants, more dealers will be invited to join the project as it moves forward.
Goldman first began looking at this issue 18 months ago in the wake of the legal dispute over a credit default swap contract between UBS and Deutsche Bank, said Smith.
The week on Risk.net, July 7-13, 2018Receive this by email