Amidst the economic and financial markets instability of the past two years, the International Swaps and Derivatives Association, Inc. (ISDA) and the privately negotiated derivatives industry have made significant progress in improving and standardizing the CDS business, with further improvements underway. These include: strengthening and diversifying counterparty risk management mechanisms, reinforcing the industry’s infrastructure, assessing the appropriate approach to capital and accounting, and enhancing operational efficiencies and transparency.
“The privately negotiated derivatives industry clearly recognizes its responsibility to help strengthen the global financial markets, as evidenced by the scope and scale of our collective efforts to identify and reduce the sources of risk in our business,” said Eraj Shirvani, ISDA chairman and head of Fixed Income EMEA at Credit Suisse. “This in fact is why ISDA was founded and it is a mission to which we remain deeply committed. Since the credit crisis began, no other area of the financial markets has worked as strenuously or effectively to enhance financial stability as the privately negotiated derivatives business.”
“Today there is a broad consensus for a comprehensive plan to modernize and protect the integrity of the financial system,” said Robert Pickel, executive director and chief executive officer, ISDA. “ISDA supports the key concepts underlying reform efforts, including appropriate regulation for all systemically important financial institutions, stronger counterparty risk management, increased transparency, and a more resilient and efficient infrastructure.” The industry’s ongoing initiatives are a key focus of ISDA’s 2009 Regional Conference in London today.
"ISDA will continue to lead and participate in these initiatives in a constructive way," Mr Pickel continued. "The Association and the industry will not wait for legislation or additional regulation to demonstrate their commitment to these principles."
Key accomplishments and initiatives include:
· Stronger and more diverse counterparty risk management, including increased use of clearinghouses: More than $2 trillion of credit default swaps contracts have been cleared in North America and Europe since March. Earlier this month, ISDA and 15 large derivatives dealers publicly committed in a letter to the Federal Reserve Bank of New York that the firms would submit 95% of new eligible credit default swap trades for clearing within 60 days by October 2009, and 90% of new eligible interest rate swap trades beginning December 2009.
· Improved transparency: ISDA is working to enhance market transparency in several important ways. The Association appointed buy-side participants to join with the dealer community on the ISDA Board and on many industry initiatives, such as the Credit Derivatives Determinations Committee.
In addition, ISDA is working to increase the flow of information on the derivatives business to the regulatory community as well as to the general public. More information on exposures and activity is available through DTCC’s trade information warehouse. ISDA has made available to all participants a CDS standard model that improves consistency and reduces operational differences regarding the calculation of CDS prices. And the ISDA CDS MarketplaceSM website brings together information, data and statistics on the CDS business. ISDA and industry participants have also developed a request for proposals from vendors interested in helping to construct a trade information warehouse for interest rate swaps, similar to that which currently exists for credit default swaps.
· A resilient operational infrastructure: In April, ISDA successfully launched the Big Bang Protocol, which incorporated auction settlement terms into standard CDS documentation. It also incorporated Determinations Committee resolutions into the terms of standard CDS contracts. The Committees are comprised of dealer and buy-side representatives to determine whether credit events have taken place and what obligations can be delivered. The Big Bang Protocol is important as more than 40 credit events have been processed globally since October 2008.
ISDA also increased operational efficiency through industry-wide compression or ‘tear-up’ efforts that helped to significantly reduce the notional amount of CDS outstanding. The industry continues to improve in other key areas, such as electronic processing, collateralized portfolio reconciliation and reduction in outstanding confirmations. Electronic matching rates of eligible confirmation events increased from 69 percent in 2007 to 85 percent in 2008 for equity derivatives, 70 percent to 78 percent for interest rate derivatives and 96 percent to 98 percent in CDS. The level of aged confirmations continues to steadily decline, with equity derivatives at 1.3 business days’ worth of outstanding confirmations in 2008, compared with 2.4 days for 2007; interest rate derivatives at 1.3 days vs. 0.7 days and CDS at 0.3 days compared to 0.1 days.
Looking forward, ISDA will remain proactive in identifying and reducing the sources of risk in the industry. ISDA remains committed to working on a broad number of fronts – risk management, operations, trading practices, legal, technology – to further strengthen the robust and resilient infrastructure it has developed since its inception.
