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GENERAL INTEREST QUESTION: Should the DC reject or dismiss a general interest question posed to the DC that purports to be interpretative but instead seeks to fundamentally alter the purpose and scope of the Auction process?

This statement is submitted in connection with the General Interest Question posted to ISDA on April 18, 2018 seeking an interpretation of Section 3.2(c) of the 2016 ISDA Credit Derivatives Determinations Committees Rules (the “DC Rules”).[1] The Determinations Committee (“DC”) should reject or dismiss the April 18 General Interest Question because it improperly seeks to institute Auction-specific terms outside the context of a pending Auction. Accepting the premise set forth in the General Interest Question also would impose inappropriate burdens on the DC, introduce uncertainty and risk into the DC determination process, and run counter to the stated objectives of the ISDA CDS Auction process.

The General Interest Question purports to request the interpretation of the DC Rules in the abstract, while in fact proposing new Auction-specific terms in the absence of a Credit Event determination or pending Auction. In effect, the General Interest Question would have the DC introduce a new Deliverable Obligation Characteristic—namely that Obligations with a trading value the DC deems too low should be disqualified from an Auction. The General Interest Question thus improperly asks the DC to establish Auction-specific terms outside the context of a Credit Event or an Auction and should be rejected.

The General Interest Question also imposes an inappropriate burden on the DC. For the DC to determine if specific Obligations would produce a “low” Auction Final Price, the DC would be required to form a view as to the relative expected recovery values of the Reference Entity’s outstanding obligations. The DC would become the arbiter of value, guess at the course and result of an impending Auction, and thereby preempt and directly undercut the very purpose of the Auction— to determine the expected recovery value of the Reference Entity’s cheapest-to-deliver Deliverable Obligation in a transparent, market driven process. The established highly transparent and tested Auction process enables market participants to settle CDS positions efficiently based on a market-wide price following a Credit Event, and contributes significantly to the functioning of the CDS market.

Moreover, in order to determine that a particular Obligation would produce an “artificially” low Auction Final Price, the DC will need to engage in a time consuming and possibly futile fact finding mission, something that it is not designed or equipped to do. To effectively discharge the discretionary responsibility required under the new rule requested in the April 18 General Interest Question, the DC would have to investigate and second-guess the subjective rationale and state of mind of the Reference Entity and other market participants without any objective guidelines. Indeed, the DC would have to definitively answer several questions that are unlikely to have clear and objectively determinable answers such as: which motivation will disqualify an Obligation? Which intent will be deemed acceptable behavior? The endeavor would introduce considerable unpredictability and uncertainty into the CDS market and the DC determination process, and leave market participants speculating about which Obligations retroactively may be excluded from an Auction despite the fact that they otherwise squarely fit within the standard Deliverable Obligation Characteristics. Adopting the premise put forth in the April 18 General Interest Question would fundamentally alter the accepted Auction price-finding model from an ISDA DC supervised transparent process with pre-defined rules allowing the market to determine value, to a one where the DC makes initial value determinations on an ad hoc basis, limiting the role of the market. If such a fundamental change were advisable, which it is not, it should only be considered by ISDA through an ISDA Board supervised process, and not by means of the answer to a general interest question.

Last week, on April 11, 2018, the ISDA Board issued a statement to reiterate the importance for the CDS market that a DC base its determinations on objective information only:

“The credit event determination process does not allow the DC to make subjective decisions, or to consider the intent or good faith of the parties that put in place the arrangements leading to a potential credit event. This ensures the process is objective and predictable, and decisions can be made quickly.”[2]

The determination of the Auction terms once a Credit Event determination has been made is equally important and must apply the same rationale. Market participants desire objective, predictable and speedy determinations with respect to Credit Events and the settlement of CDS. A departure from the established and tested approach would be detrimental to the functioning of the markets, chill market participants’ confidence to transact in CDS and would be inconsistent with the stated objectives of the ISDA CDS Auction process.

Accordingly, we respectfully request that the DC reject or dismiss the General Interest Question submitted yesterday.

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We confirm that a copy of this statement may be provided for information purposes only to the members of any Credit Derivatives Determinations Committee convened under the DC Rules in connection with the General Interest Question to consider the issues discussed herein, and that it may be made publicly available on the ISDA Credit Derivatives Determinations Committee website. We accept no responsibility or legal liability in relation to its contents.

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1 Capitalized terms used but not defined herein use the meanings given to them in the DC Rules or the
2014 ISDA Credit Derivatives Definitions, as applicable.

2 See ISDA Board Statement on Narrowly Tailored Credit Events, April 11, 2018, available at: https://www.isda.org/2018/04/11/isda-board-statement-on-narrowly-tailored-credit-events/.

General Interest Question PDF Submission (submission also being emailed)