Dura auction breaks new ground

The bankruptcy of US auto parts manufacturer, Dura Operating Corporation, has led to another first for the settlement of credit derivatives trades. The International Swaps and Derivatives Association's 2006 Dura Protocol permitted cash settlement of single-name, index, tranches and other credit derivatives transactions. Previous protocols enabled cash settlement of index trades only.

"We've undertaken the first auction with a mechanism that extends to single-name and bespoke trades," says an Isda spokeswoman. "It's a name that's traded relatively lightly, making it a good one to start with."

Thanks to the experience of dealing with six previous credit events, Isda and its lawyers are now well practised in creating new versions of protocols for the settlement of credit derivatives trades after credit events. These protocols have been key to facilitating the settlement process by allowing counterparties to cash-settle credit derivatives positions rather than relying on physical delivery.

The auction to finalise prices on Stockton, Illinois-based Dura's senior and subordinated bonds was held on November 28 and administered by New York-based electronic trading platform Creditex and London-based data provider Markit. Previous auctions to determine the final price for defaulted bonds consisted of only one bidding period. However, the Dura auction featured two bidding periods. The idea behind this was to generate a price based on supply and demand dynamics, rather than dealers guessing what the bonds might be worth, explains Mazy Dar, head of electronic platforms at Creditex.

"One of the issues was that previous auctions would give a final price, but if you went to the market you would find people wouldn't want to trade at that price," says Dar.

For the Dura auction, the participating dealers entered two-way market prices in the first bidding period, along with their physical settlement requests. After the first bidding period, Creditex and Markit published an inside market mid-point price - an indicative level based on two-way markets entered into the auction by 11 participating dealers. The open interest - or the net balance between buy and sell physical settlement requests entered by participating dealers - was also published. During the subsequent bidding period, on the same day, dealers submitted limit bids to fill the open interest. The final price was fixed at 3.5% for subordinated bonds and at 24.125% for senior bonds.

Rachel Wolcott.

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