ISDA Determination Committee in Determining Credit Event

picture1Overview ISDA

The International Swaps and Derivatives Association (ISDA) is a trade organisation of participants in the market for over-the-counter (OTC) derivatives. Since 1985, the International Swaps and Derivatives Association (ISDA) has worked to make the global derivatives markets safer and more efficient, for example by creating a standardised contract (the ISDA Master Agreement) for all participants who want to enter into derivatives transactions.[1]

Not only ISDA Master Agreement, ISDA has also developed standard documentation for derivatives such as schedule to the master agreement, credit support documents (optional), and confirmation.[2] The results of this are that (i) the time and cost involved to negotiate and agree derivative transactions has been greatly reduced (ii) the use of derivatives has grown significantly.[3] Therefore, it is not surprising that derivatives account nearly half of the total outstanding notional worldwide, and up to 85 percent of total outstanding notional of contracts with reference to emerging market issuers.[4]

Nowadays, ISDA has over 850 member institutions from 67 countries. In reflecting the global scope of the OTC derivatives markets and its membership, the Association’s presence is divided into several regions, which are Canada, United States, Latin America, Japan, Asia Pacific, Europe and Emerging Markets across Europe, the Middle East and Africa.[5] Besides having specific regional offices, ISDA also has several committees namely:[6]

  • Functional Committees;
  • Product Committees;
  • Region-Specific Committees;
  • ISDA Industry Governance Committee (IIGC) and Regulatory Implementation Committees;
  • Benchmark Committee; and
  • Determination Committees (DC).

The ISDA Credit Derivatives Determination Committee

The Determination Committee (DC) was formally established in 2009 with the publication of the DC Rules in connection with the Big Bang Protocol and the March 2009 Supplement to the Credit Derivatives Definitions.[7] The ISDA Credit Derivatives Determinations Committees (DCs) each comprise 10 sell-side and five buy-side voting firms, alongside three consultative firms and central counterparty observer members. The DC currently exists in each of the following regions: Americas, Asia excluding Japan, Australia-New Zealand, EMEA (Europe), and Japan.[8] Each DC deliberates issues involving reference entities traded under transaction types that relate to the relevant region. The determinations made by the DCs are governed by the Determinations Committees Rules. The latest amendment of DC Rules is on 2016 ISDA DC Rules January 10, 2016.[9]

Basically, the existence of the DC is to compare the facts of specific events with the provisions of standard CDS contracts (including Credit Derivatives Definitions) to make determinations regarding the key provisions of such contracts, including:[10]

  • Whether a Credit Event (an event that would trigger the settlement of the CDS and allow the protection buyer to obtain payment for the credit protection purchased) has occurred;
  • Whether an auction should be held to determine the final price for CDS settlement; and
  • Which obligations should be delivered or valued in the auction.

However, the Determination Committee is different from international commercial arbitration, because the decisions of DC applies to all effected transactions of market participants who have adhered to the Big Bang Protocol.[11] Additionally, unlike traditional adjudicative bodies, the DCs do not resolve party disputes based on adversarial submissions. Instead, they answer standard-form questions posed by market participants, who choose the questions from a limited menu.[12]

The Role of The ISDA Credit Derivatives Determination Committee in Credit Default Swap Transactions

In principle, when a CDS contract is entered into, the two parties thereto agree that the contract will be governed by the Credit Derivatives Definitions and that the determinations of the relevant DC will be binding on the contract. This section will discuss the procedures of the DC when examine a question from eligible market participant.

  1. Procedures in Determination Committee

First of all, if there is a potential occurrence of a credit event, in order to convene the Committee, any eligible market participant (any counterparty to a relevant CDS transaction) can request a meeting of the Committee by notifying the DC Secretary (ISDA) regarding the issue. The issue posted is in a form of question to the Determinations Committee on its website (http://dc.isda.org/submit-a-request/), and it shall include a reasonably detailed description of all of the issues. [13] When raising a question to the DC, supporting publicly available information are required as evidence, therefore it is very important.

Following effective receipt of a request for a meeting of a Committee, the DC Secretary will determine each affected reference entity, the implicated transaction type and the relevant DC Voting Members for each Region.[14]

In order to hold a meeting of a Convened DC to deliberate the request, at least one Convened DC Voting Member must agree to deliberate such request, while regarding to a request that has been designated as a general interest question (anonymous), in this case, at least two Convened DC Voting Members must agree to deliberate such request.  However, in instances where a Convened DC Voting Member proposes a request, such Convened DC Voting Member shall count fulfil the applicable agreement requirements (automatically accepted).[15]

Furthermore, a Convened DC cannot hold any deliberations or take any vote unless a quorum is reached. At least 80% of the Convened DC Voting Members must be present (either in person or by telephone, videoconference or web conference), if the 80% Requirement is not satisfied at any meeting of the Convened DC, at least 60% of the Convened DC Voting Members must be present for the next meeting and all subsequent meetings of such Convened DC, and if the 60% Requirement is not satisfied at a relevant meeting, at least 50% of the Convened DC Voting Members must be present for all subsequent meetings of such Convened DC is required for a credit event to be declared.[16

Basically, there are two things that matter in determining a credit event. First, the decision can only be made based on publicly available facts submitted to the DC. Second, these facts need to be referenced to the ISDA Credit Derivatives Definitions to determine whether a credit event has occurred. This makes the process objective and predictable as possible, the decisions quickly made as well as providing certainty to market participants.

If the DC members have accepted the question and present in accordance with quorum rules, then the DC begins its discussion. Each Convened DC Voting Member only has one vote on a Convened DC, and it is deemed a binding vote.[17] After obtained a result, the DC Secretary will promptly publish the result on its Website and an eligible market participant will know whether a Credit Event has occurred.

If it is deemed that a credit event has occurred, the DC will also consider whether to hold an auction to determine the final price for CDS settlement and which obligations the reference entity that the credit protection buyer must deliver to the credit protection seller or valued in the auction. The DC will also publish the auction settlement terms as a regulation to conduct the auction on its website.

  1. Procedures in External Review

In the event that DC has made a binding vote, but it is not by supermajority. Then it shall be referred to the External Review.[18] External review contains with a minimum of 3 (three) external reviewers and up to five independent experts for consideration (the fourth and fifth members, if any, are essentially back-ups). They are selected by Convened DC from the list which provided by ISDA.[19]

In relation with the external review procedure, each voting members in his particular position shall appoint one or more person to present their argument to the external reviewers and participate in oral argument.[20] Then the decision of external review should be decided in accordance with the DC decision based on two conditions. First condition, if more than 60% but less than 80% of the Convened DC votes for particular outcome, unless the external reviewers unanimously conclude that other outcome is the better answer.[21]

Second condition, while the DC decision is less than or equal to 60% in favour of specific outcome, the external review decision will be decided in accordance with such DC decision, unless two of three external reviewers consider  that other outcome is the better answer.[22] And such decision shall be deemed as the final decision. The External Reviewers will notify the DC Secretary for publishing the decision of the External Reviewers on its website within 5 hours after receiving such information from the External Reviewers.[23]

 

Case Study: General Motors

On 1 June 2009, General Motors and three domestic subsidiaries filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the US Bankruptcy Court for the Southern District of New York.[24] Immediately, ISDA Determinations Committees in America deliberated DC Issue No. 2009060102 containing 4 (four) questions as follows:[25]

  • Has a Bankruptcy Credit Event occurred with respect to General Motors Corporation?
  • If a Credit Event did occur, is the date of the Credit Event June 1, 2009?
  • Is the date on which the DC Secretary first effectively received both a request to convene the Committee and Publicly Available Information that satisfies the requirements of Section 2.1(b) for the Credit Event with respect to General Motors Corporation June 1, 2009?
  • Should ISDA hold one or more auctions to settle Relevant Transactions with respect to which a Credit Event Resolution has occurred in accordance with the terms set out in the form of Credit Derivatives Auction Settlement Terms with respect to General Motors Corporation?

Then The ISDA announced that its Americas Credit Derivatives Determinations Committee resolved that a bankruptcy credit event occurred in respect of General Motors Corporation, one of the world’s largest automakers. All Convened DC Voting Members which were present at that day gave 15 ‘Yes’ votes and 0 ‘No’ votes for all questions. The Committee also voted to hold an auction for General Motors Corporation. The members of America Determination Committee as follows:

No. DC Voting Members Vote
1. Bank of America / Merrill Lynch Yes
2. Barclays Yes
3. Citibank Yes
4. Credit Suisse Yes
5. Deutsche Bank AG Yes
6. Elliott Management Corporation Yes
7. Goldman Sachs Yes
8. JPMorgan Chase Bank, N.A. Yes
9. Legal & General Investment Management Limited Yes
10. Morgan Stanley Yes
11. Pacific Investment Management Company LLC Yes
12. Primus Asset Management, Inc. Yes
13. Rabo bank International Yes
14. The Royal Bank of Scotland Yes
15. UBS Yes

Table 1. DC Voting Members America 2009

In light of the speed, the Obama administration was keen to finalise the situation with General Motors, there was concern that unless the auction was held quickly, there might not be any deliverable obligations remaining due to the speed at which the process was proceeding and the potential for a widespread debt-for-equity swap.[26]

As a result, the DC expedited the auction timetable. The final list was published on 10 June 2009 with the auction on 12 June 2009.

Bibliography

[1] (http://www.investopedia.com/terms/i/isda-master-agreement.asp) last visited (5-11- 2016)

[2] The master agreement is an umbrella document which includes the boilerplate provisions (unless varied by the schedule to the master agreement); The schedule to the master agreement is an amend of the terms of the master agreement as required by the parties; The credit support documents (optional) is a method of providing collateral or security for the obligations under derivative transactions; The confirmation is a document which contains the economic terms of an individual trade.

[3] (https://www.lexisnexis.com/uk/lexispsl/bankingandfinance/document/) last visited (5-11- 2016)

[4] See J. Chan-Lau, Anticipating Credit Events Using CDS with an Application to Sovereign Debt Crises, IMF Woking Paper, at 4 (2003)

[5] (http://www2.isda.org/regions/) last visited (5-11- 2016)

[6] (http://www2.isda.org/committees/) last visited (5-11- 2016)

[7] ISDA Credit Derivatives Determinations Committees, Paper on the four-year history of the formation, structure and workings of the ISDA Credit Derivatives Determinations Committees, at 1-2 (2012)

[8] (http://dc.isda.org/about-dc-committees/) last visited (5-11- 2016)

[9] (http://dc.isda.org/dc-rules/) last visited (5-11-2016)

[10] ISDA Credit Derivatives Determinations Committees, Paper on the four-year history of the formation, structure and workings of the ISDA Credit Derivatives Determinations Committees, at 1-2 (2012)

[11] C. Baker, Regulating the Invisible: The Case of Over-the-Counter Derivatives, Notre Dame Law Review, at 1287 (2010)

[12] A. Gelpern & M. Gulati, CDS zombies, European Business Organization Law Review, at 9 (2012)

[13] ISDA Credit Derivatives Determinations Committees Rules 2016 version Section 2. 2.1 (a)

[14] ISDA Credit Derivatives Determinations Committees Rules 2016 version Section 2.2.1 (e)

[15] ISDA Credit Derivatives Determinations Committees Rules 2016 version Section 2.2.2 (a)

[16] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 2.2.3 (a)

[17] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 2.2.3 (b)

[18] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 4.1. (a)

[19] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 4.3

[20] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 4.5 (a)

[21] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 4.6 (d)

[22] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 4.6 (d)

[23] ISDA Credit Derivatives Determinations Committees Rules 2016 version, Section 4.6 (f)

[24] (http://www.isda.org/press/press060109.html) last visited (8-11-2016)

[25] (http://dc.isda.org/cds/general-motors-corporation/) last visited (8-11-2016)

[26] (https://www.whitehouse.gov/the-press-office/fact-sheet-obama-administration-auto-restructuring-initiative-general-motors) last visited (10-11-2016)

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