Thomson CDS trades settled as small bang protocol opens

Three credit event auctions were held on October 22 to settle credit default swaps (CDSs) referencing the debt of Paris-based electronics firm Thomson, more than 10 weeks after a restructuring credit event was declared by the regional credit derivatives determinations committee on August 12.

The auctions represent a landmark for the European credit derivatives industry, as they settled trades triggered by the first restructuring credit event under the small bang protocol, which introduced a new system of maturity limitation buckets to allow cash settlement via auction following a restructuring. The protocol came into effect on July 27 (Risk October 2009, pages 39-41).

As €1,100 million of Thomson's €2,839 million of outstanding debt was privately placed, it took the determinations committee longer than expected to identify the deliverable bonds and loans to allow CDS holders to trigger their contracts. Dealers also wanted to wait until Stockholm-based technology company TriOptima had carried out a series of portfolio compression cycles to reduce the volume of outstanding trades to be settled. In a cycle completed on October 6, banks eliminated 8,105 single-name trades with a notional value of $19.6 billion and 5,232 index tranche trades with a notional value of $215 billion, according to TriOptima.

Once the final list of deliverable obligations had been published, protection sellers had two days and protection buyers had three days to trigger their contracts. Three auctions were scheduled for October 22 to settle transactions falling into the two-and-a-half-year maturity bucket, the five-year maturity bucket and the seven-and-a-half-year maturity bucket.

The recovery rate in the two-and-a-half-year bucket was set at 96.25%, meaning protection sellers had to pay out just 3.75 cents for every euro of debt insured. In the five-year bucket, the recovery rate was set at 65.125%, while the recovery rate for the seven-and-a-half-year bucket was fixed at 63.25%.

Even before the Thomson trades had settled, the International Swaps and Derivatives Association announced it had reopened the small bang protocol for adherence to give smaller firms and new entrants to the market the opportunity to take advantage of its provisions.

During an initial adherence period, which ran from July 14 to July 24 this year, 2,132 parties signed up to the protocol. However, Isda announced on September 30 that the protocol would reopen from October 5, 2009 until January 31, 2011 - a period of nearly 16 months.

According to an Isda official, the extension of the adherence period is designed to cater to those firms that began trading CDSs after the small bang came into effect on July 27. The adherence period will run until 2011 because that is when Isda plans to incorporate both the small bang and the big bang protocols, which introduced a string of other trading convention changes on April 8, into standard CDS documentation.