The New ISDA 2003 Credit Derivatives Definitions

This article does not attempt to be a complete guide but highlights some of the more important changes made in the ISDA 2003 Credit Derivatives Definitions (published by ISDA on 11 February 2003). In relation to the Restructuring Credit Event, the 2003 Credit Derivatives Definitions also consolidate a number of supplements published by the Credit Derivatives Market Practice Committee during 2001. The structure of the 2003 Credit Derivatives Definitions remains unchanged.

We will look at:

• changes to the Restructuring and Repudiation/Moratorium Credit Events
• “Not Subordinated” replaces “Pari Passu Ranking”
• new Notice of Physical Settlement
• alternative settlement procedures

2001 Supplements

The 2003 Credit Derivatives Definitions consolidate the provisions of the following supplements:

• the Restructuring Supplement dated 11 May 2001
• the Supplement Relating to Convertible, Exchangeable or Accreting Obligations dated 9 November 2001 (the so-called ‘Convertible Supplement’), and
• the Supplement Relating to Successor and Credit Events dated 28 November 2001 (the so-called ‘Successor Supplement’)

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Restructuring

Parties to a Credit Derivatives Transaction now have the choice of one of four alternative approaches in relation to the Restructuring Credit Event:

• Not to use Restructuring (i.e. a Japan market practice)


• Use Restructuring ‘as is’ (i.e. under the provisions under 1999 Credit Derivatives Definitions)


• ‘Modified’ Restructuring (or “Mod R” i.e. the position under the above mentioned Restructuring Supplement)


• ‘Modified Modified’ Restructuring (or “Mod Mod R”)

Mod R is generally favoured in North America while Mod Mod R, is used more by in the European markets. The main differences between these two approaches are in:

• the final maturity date of the Deliverable Obligation, and
• the (Fully Transferable) nature of the Deliverable Obligation

Mod R:

• the Deliverable Obligation cannot have a final maturity date which (a) is more than 30 months following the Scheduled Maturity Date and (b) occurs after the earlier of (i) 30 months following the date of Restructuring, and (ii) the latest final maturity date of any Bond or Loan of the Reference Entity which is the subject of Restructuring, and
• the obligations must be Fully Transferable Obligations (for detail cf. Section 2.32(b))

Mod Mod R:

• the final maturity date of the Deliverable Obligation cannot be more than (a) 30 months following the Scheduled Maturity Date and (b) (i) 60 months (in the case of Bonds and Loans) and 30 months (in the case of all other Delivarable Obligations) following Restructuring, and
• Deliverable Obligations are Conditionally Transferable Obligations (for detail cf. Section 2.33(b))

Please note that:

• Both Mod R and Mod Mod R are intended to apply to physically-settled Transactions and where Restructuring is the only Credit Event specified in the Credit Event Notice
• To use Mod R, select “Restructuring Maturity Limitation” and “Fully Transferable Obligation”
• To use Mod Mod R, select “Modified Restructuring Maturity Limitation” and “Conditionally Transferable Obligation”
• A Restructuring can apply only in respect of Obligations that have more than three holders unless Multiple Holder Obligation (for detail cf. Section 4.9) is specified to be inapplicable
• Multiple Credit Event Notice will apply unless specified otherwise (for detail cf. Section 3.9)

Repudiation/Moratorium
The Credit Event has been amended so that the repudiation or imposition of a Moratorium must be declared by an authorised officer (of the relevant Reference Entity or the Government Authority) and the declaration will only constituted a Potential Repudiation/Moratorium. A Repudiation/Moratorium will occur only if a Failure to Pay or a Restructuring occurs with certain periods specified (i.e. before the Repudiation/Moratorium Evaluation Date, cf. Section 4.6(a)).

Not Subordinated Obligation
The old Pari Passu Ranking has been replaced by the new Not Subordinated Obligation. Please see the meaning of “Subordination” in Section 2.19(b)(i)(B). Please note that whether an Obligation is or is not Subordinated is determined as of the Trade Date or the issue date of such Obligation, whichever is the later.

Notice of Physical Settlement
The Notice of Physical Settlement is supposed to be binding but it is still possible to make amendments to some of the information. The Buyer may for example amend the notice before the Physical Settlement Date and correct any errors or inconsistencies in relation to Deliverable Obligations prior to the Delivery Date.

Alternative Settlement
The 2003 Credit Derivatives Definitions introduce two alternative delivery procedures to enable the Buyer to make the delivery:

• Buy-in Bond Not Delivered (Section 9.9) under which the Buyer will be able to deliver unless and until the Seller exercises the right to buy-in
• Alternative Procedures Relating to Loans Not Delivered (Section 9.10) under which the Buyer will be able to deliver Bonds or Loans in lieu, subject to certain requirements set out in Section 9.10(a)

Please note that the second procedure does not apply where:

• Reference Obligations Only (cf. Section 2.19(a)(ii)) is specified, or
• Partial Cash Settlement is applicable (cf. Section 9.10)

Guarantee Obligations
For discussion relating to changes made in relation to guarantee obligations, please refer to our article on ISDA 2003 Guarantee Supplement.
The 2003 Credit Derivatives Definitions will no doubt replace the 1999 Credit Derivatives Definitions over time but perhaps not before more changes or further supplement (cf. e.g. the ISDA 2003 Guarantee Supplement). The ‘official’ implementation date of the 2003 Credit Derivatives Definitions was agreed to be 20 June 2003. It is however not binding on market participants.

If you would like to discuss any of the above, please do not hesitate to contact us at main@derivativeslawyer.com.

Please also refer to our other articles in the series: