Bail-in Highlights Need for CDS Reform

Here is a link to an article which reports that ISDA has drafted a proposal to add a new credit event for financial credit default swaps.  The proposal is in response to the:

  • introduction of the European Commission’s bail-in framework (part of a package of legislation aimed at bolstering bank recovery and resolution) which will enable governments to write down – or “bail-in” – bank debt of failing institutions in order to avoid bankruptcies and ensure bondholders shoulder bank losses rather than taxpayers; and
  • performance of credit default swaps in the lead-up to the nationalisation of SNS Reaal earlier this year.

The new credit event would be triggered in the event of a government authority using a restructuring and resolution law to write down, expropriate, convert, exchange or transfer a financial institution’s debt obligations.  The trigger would be subject to minimum thresholds in terms of the amount of debt affected, but once exceeded, the protection buyer would be able to deliver the:

  • written-down bonds (as valued on their outstanding principal amount prior to the write-down); or
  • proceeds or other instruments received following application of the ‘bail-in’ tool (provided that these would have qualified as ‘Deliverable Obligations’ immediately prior to the triggering event.

Senior debt will be subject to the EU bail-in provisions from 2018 although recent comment from the EU suggests that this could be brought forward to 2015.  ISDA’s proposals will now undergo consultation with new credit definitions expected by the end of 2013.

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