Credit derivatives majors form data alliance

Goldman Sachs, Deutsche Bank and JP Morgan Chase have launched a credit derivatives market data scrubbing and sharing project meant to head off disputes among market participants over the terms of their contracts.

The Reference Data Scrubbing Project will establish the ongoing legal existence of the reference entities (REs), the credits on which the derivatives are written, traded in the market, their correct names, the existence of reference obligations (ROs) - the debt issued by the reference entities - and the contractual relationship between REs and ROs. The dealers say that having all market participants rely on the same set of clean data will reduce an unintended source of basis risk.

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.