European CDS dealers to follow US to fixed coupons

An agreement between the major dealers to move to standardised fixed coupons for trading European credit default swaps (CDSs), following a similar move in North America, could speed global moves towards central clearing, say market participants.

The dealers - believed to include Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley and UBS - reached an agreement on April 17 to trade European CDSs with standardised coupons of 25, 100, 500 or 1,000 basis points, with a provisional target set at the end of June. The International Swaps and Derivatives Association could not be reached to confirm the move, but a leading dealer confirmed it was a binding arrangement.

"The changes will apply to all new CDS contracts originated in Europe," John Cortese, head of European high-yield trading at Barclays Capital in London, told Risk News. "The use of fixed coupons will make CDSs easier to clear on a central platform, because you have greater fungibility and standardisation, rather than a variety of different coupons outstanding."

The agreement follows the introduction of a number of changes to the global CDS market on April 8, collectively known as the 'big bang' protocol. The protocol hardwires the auction settlement mechanism into contracts, introduces five regional determinations committees to decide whether credit or succession events have occurred, and implements rolling look-back periods of 60-90 days from the current day for the protection provided by a CDS.

Alongside the big bang protocol, North American CDSs were also adapted on April 8 to exclude modified restructuring as a credit event and introduce fixed coupons of 100bp or 500bp to be paid on a quarterly basis. "The move to fixed coupons makes the single-name market more like the index market," said Jason Quinn, co-head of high-grade/high-yield flow trading at Barclays Capital in New York. "It makes them more fungible, more index-like and more bond-like, so they're more like standard instruments and more easily cleared."

Both the Federal Reserve Bank of New York and the European Commission have been pushing dealers to use central clearing platforms (CCPs) as a risk mitigant, but new research published in the US this week suggests a CCP might not be the panacea some have suggested.

Darrell Duffie, professor of finance at Stanford Graduate School of Business, and doctoral student Haoxiang Zhu argue that adding a CCP for one class of derivatives can actually reduce netting efficiency and lead to an increase in collateral demands and exposure to counterparty default.

They also suggest adding multiple CCPs in Europe and the US could be damaging. "Whenever it is efficient to introduce a CCP, it cannot be efficient to introduce more than one CCP for the same class of derivatives," the academics noted.

See also: Ups and Downs
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