For Immediate Release Monday,
December 19, 2005
For More Information, Please Contact:
ISDA Publishes Pay-As-You-Go Forms for CDS
on ABS
The Credit
Derivative Transaction on Asset-Backed Security with Pay-As-You-Go Settlement
(Form II) template, published today, is anticipated to be primarily of use in
flow transactions.
Under a PAUG instrument, the seller of protection pays the protection buyer in the event that an interest shortfall, a writedown or a principal shortfall occurs with respect to the relevant underlying instrument.
“Tailoring
documents to individual settlement approaches assists in the continued growth
and diversification of the credit derivatives product.” said
There are several key differences between the
two PAUG templates:
* Form II eliminates implied writedown provisions and requires seller payments only upon the occurrence of writedowns that are contemplated under the underlying instruments and that (a) reduce the outstanding principal amount of the reference obligation or (b) reduce the amount of interest payable on the reference obligation.
Form I, on the other hand, includes implied writedown provisions that would require payments by the seller and buyer respectively if losses occur to the underlying instruments that do not result in reductions of the outstanding principal of the reference obligation.
* Under Form II, changes in the coupon of a fixed rate obligation or the spread of a floating rate obligation are given effect, and the transaction continues. If the coupon or spread of the reference obligation increases, the fixed rate also increases.
By contrast, Form I contains step-up provisions that give the buyer the option to terminate the transaction or to continue at the higher rate. A "step-up" is an increase in the coupon of the reference obligation due to the failure of the issuer or a third party to redeem, cancel or terminate an obligation in accordance with the underlying instruments
* Form II determines any interest shortfall after giving effect to all available funds cap reduction provisions, including any provision of the underlying instrument that provide for the capitalization or deferral of interest on the reference obligation, or which limit the interest entitlement or rate at which interest is determined pursuant to a prepayment interest shortfall, basis risk shortfall, or funds cap provision.
Form I determines interest shortfalls without giving effect to available funds cap or other provisions in the underlying instruments which limit distributions and provide for capitalization or deferral of interest, or that provide for the extinguishing or reduction of such payments. Form I also contains interest shortfall cap provisions that can limit interest to either a fixed or variable cap.
* Form II does not provide a buyer’s option for physical settlement, in contrast to Form I, under which the buyer has the option, when a credit event occurs, to reduce all or a portion of the notional amount via physical settlement.
Neither template is
for use with negative basis trades.
ISDA is the global trade association representing leading participants in the privately negotiated derivatives industry. ISDA was chartered in 1985, and today has more than 650 member institutions from 47 countries on six continents. These members include most of the world's major institutions that deal in privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-the-counter derivatives to manage efficiently the financial market risks inherent in their core economic activities. Information about ISDA and its activities is available on the Association's web site: www.isda.org.