The "Big Bang" in the CDS market

13 December 2010

(Extract from page 65 of BIS Quarterly Review, December 2010)

To help standardise single-name CDS contracts, the International Swaps and Derivatives Association (ISDA) introduced a number of documentation changes in its "Big Bang" of April 2009. These helped to standardise both the regular coupon payments made by single-name CDS and the default-contingent payments. The changes are summarised in Table A.

One major change that helped to standardise coupon payments was the introduction of a small number of standard coupon rates. In combination with standard contract sizes, these fixed the size of coupon payments, which were already paid on standard dates (20 March, 20 June, 20 September and 20 December). To compensate for any differences between the appropriate premium and the chosen standard coupon rate, counterparties exchange an upfront payment. A change was also made to the first coupon. Previously, this was either a small coupon paid on the first coupon date or a large coupon paid on the second coupon date, depending on when contracts became effective. Now, first coupons are full coupons, and upfront payments are adjusted accordingly.

To help standardise default-contingent payments, the Big Bang harmonised across contracts the triggers of credit events and their consequences. For example, it established Determinations Committees for determining whether a credit or succession event has occurred as the standard condition in contract documentation. This has reduced the scope for different contracts on the same reference entity to disagree about whether such events have occurred. The Big Bang also hardwired into documentation that the size of payments following credit events would be determined by an auction process. The prices emerging from such auctions ensure that all protection sellers transfer the same value to protection buyers. Finally, the Big Bang changed the dates on which contracts are considered to have become effective from the business day following the trade to a set of standard dates. This ensures that all outstanding contracts are affected by the same events, even when these are reported with a lag.