Skip to main content

When bank depositors in Cyprus were asked to pay part of the tab for a financial rescue, that raised the question of what constitutes a bailout.Pavlos Vrionides/The Associated Press

The global body responsible for derivatives oversight has started the process of redefining the rules for credit default swaps.

The swaps are like a form of insurance against corporate debt. Typically, fixed-income investors buy them so that they will be reimbursed should a bond issuer go bankrupt. They can also be used by investors to bet again a company's – or a country's – financial health.

But a number of events have called into question the rules around what constitutes a "credit event" that forces a payment to the holders of CDS.

During the restructuring of Greece's debt, for instance, government bonds took a haircut and lost 53.5 per cent of their value. But companies on the hook for paying out CDS insurance argued that the deal wasn't a full bankruptcy and therefore no payments were needed.

Another wrinkle cropped up earlier this year, when bank depositors in Cyprus were asked to pay a portion of the tab for a financial rescue of the country, raising the question of what constitutes a proper bailout.

The current review process, co-ordinated by the International Swaps and Derivatives Association Inc., is the first time in a decade that the definitions of a credit event have been revisited. At this point, the consultations are only in early stages, and the scope of the review is much broader than simply hammering out proper definitions.

"This is an ongoing process and only one step of the entire project," ISDA spokesperson Lauren Dobbs wrote in an e-mail.

For now, ISDA's credit steering committee has put together some proposals and these will now be released for comment from the body's members. If all goes according to plan, any new definitions could be in place by the end of 2014. However, there is no guarantee that the current definitions will be changed.

Even so, many investors believe the review is necessary because uncertainty has spread through the markets, and that can quickly lead to pandemonium – especially when billions of dollars are on the line. Fast-changing government rules also make the review timely.

Since the so-called "bail-in" was introduced in Cyprus, European officials have hinted that they would like to see more of them if financial institutions continue to need rescue funds.

The ISDA is considering how to clarify for investors what constitutes a new "credit event" that would trigger the insurance payments.

"The problem is that while writedowns may be caught as restructuring credit events under the current definitions, it's not always clear, and you may get a trigger event in some circumstances and not others," Mark New, assistant general counsel at ISDA told International Financing Review, a division of Thomson Reuters.

"By including a new, separate credit event you will get a better clarity of outcome," Mr. New said.

(Tim Kiladze is a Globe and Mail Reporter.)

Return to Streetwise home page.

Report an editorial error

Report a technical issue

Editorial code of conduct

Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 27/03/24 4:46pm EDT.

SymbolName% changeLast
TRI-N
Thomson Reuters Corp
+0.55%155.95
TRI-T
Thomson Reuters Corp
+0.41%211.67

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe