Banks support European credit master agreement changes

Investment banks have signalled their support for the International Swaps and Derivatives Association's April 5 decision to drop ‘obligation acceleration’ and ‘repudiation/moratorium’ as credit events for standard default swap transactions in Europe.

Quotes given on standard default swaps on non-sovereign, non-emerging market credits in Europe will from April 15 be made in reference to a market standard that includes only 'bankruptcy', 'failure-to-pay', and 'restructuring' as credit events, said Robert Heathcote, managing director for credit derivatives at Goldman Sachs in London. This brings European master agreements more in line with those in the US.

The two definitions still exist in the Isda credit event definitions, and will continue to be used in reference to sovereign or emerging market agreement, Heathcote told RiskNews.

'Obligation acceleration' refers to a situation where, due to default, obligations of the reference entity become due and repayable prior to maturity and have been accelerated by the holders. Depending on the circumstances, such scenarios could potentially result in either a 'restructuring' credit event or a 'failure-to-pay' credit event.

'Repudiation/moratorium' occurs where a reference entity either triggers a credit event by refusing to honour its obligations, or is prevented from making a payment because of a sovereign debt moratorium - which is more geared towards emerging market borrowers. With the omission of this credit event, the 'failure-to-pay' credit event would still be available to protection buyers in most circumstances.

"This change is an important step in further developing liquidity in the default swap market," said Heathcote. Merrill Lynch’s credit derivatives research team agreed, stating in a report that the changes should help harmonise the market towards one common standard.

Concern in Europe that dropping the two events could lead to less favourable capital relief under the proposed Basel II capital Accord have been allayed. An Isda sub-committee investigation concluded that less favourable treatment was unlikely as the current Basel II draft does not require the inclusion of either event to qualify for regulatory capital relief.