Isda proposes net physical settlement

The International Swaps and Derivatives Association has released a draft of the net physical settlement supplement to the 2003 credit derivatives definitions, which aims to simplify the settlement of credit default swaps (CDSs) after a credit event.

The supplement proposes that in the case of a credit event, open positions should be netted out and the balance cash settled. Once the supplement is published, it is hoped it will be adopted by the broader market and that legacy trades may also be subject to its terms.

This initiative has resulted from a desire to reduce volatility in the price of obligations connected with the settlement of a credit event, ensure a stronger connection between the settlement value of a CDS and the price of the bonds used to settle the CDS contract, and reduce operational risk and the expense related to the settlement of CDS contracts.

The draft supplement was published on February 17, and Isda is targeting the end of June to formalise the proposal, depending on the amount of input received.

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