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Credit Default Swaps – India FIMMDA – PDAI 13th Annual Conference 2012 DATE: 27 th January 2012 Ben Davies Head PowerPoint Presentation
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Credit Default Swaps – India FIMMDA – PDAI 13th Annual Conference 2012 DATE: 27 th January 2012 Ben Davies Head of Credit Trading, DBS Singapore. The Evolution Of A Product. 1994 : The First Ticket

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Credit Default Swaps – IndiaFIMMDA – PDAI 13th Annual Conference 2012DATE: 27th January 2012Ben Davies Head of Credit Trading, DBS Singapore


The Evolution Of A Product

  • 1994 : The First Ticket
  • Ms Blythe Masters of JP Morgan closes what’s widely acknowledged as the first CDS trade by buying protection from the EBRD on the corporation Exxon after the Exxon Valdez oil disaster spiked failure concerns on the worlds second largest oil company.
  • 1995 - 1999: The Wild West
  • All major Wall Street and London dealing houses create their first CDS desks.
  • Documentation, bespoke & a mess
  • Liquidity, none to a little more
  • Intent, a rapid change in customer focus
  • ISDA 99, the first true milestone
  • 2000 - 2003: Over Taking Bonds
  • Single name CDS now quoted across the capital structure and Rating spectrum. Volumes spike to eclipse the products that CDS was created to hedge. The death of Enron & the Dot Com collapse test the fledgling settlement process’s.
  • IBOXX & TRAC X – The birth of the indices
  • Documentation back logs, errors & fears… A scary paper trail
  • Mark-It Partners & DTCC. Transparency surges volumes once again.
  • ISDA 2003 sets the standard for standardization.

The Evolution Of A Product

  • 2004 - 2007: The Ugly Years
  • As CDO’s mutated from Cash to Synthetic the market first ran then sprinted before its time. Many good lessons however were learned from the mistakes.
  • Tranches, CDO Squares, SPV’s, The great correlation unwind….
  • Delphi & Dana personify physical settlement “Price Squeezes” & the market takes notice.
  • Market moves to IMM settlement.
  • 2008 - 2011: Hank Paulson Understands ISDA 2003
  • CDS in the Great Credit Crisis... Suddenly EVERYONE is in the same boat.
  • The importance of the word “Conservatorship”… The effect on CDS enters the decision line.
  • Big Bang, Little Bang & Standardised coupon initiatives.
  • Central clearing evolves… Dodd-Frank enforces.
  • Explosion in volumes of global index.
  • 2012 & Beyond :
  • The market nears what its always set out to need….
  • Standardised & trusted documentation representing a solid and defined legal structure.
  • True Assimilation in structure & central clearing as the norm.
  • A balance of market participants to truly reflect true value and avoid skewed pricing



Credit Default Swaps – IndiaFIMMDA – PDAI 13th Annual Conference 2012DATE: 27th January 2012Gigi P. Tan Global Content Specialist – Credit

evolution of cds history and milestones
Evolution of CDS: History and Milestones

1995/1996: The concept of a Credit protection instrument is created by JP Morgan and Single Name CDS starts to trade

  • Dec’11: Indian market sees first INR-denominated CDS trades (Rural Electrification Corp and India Railway Finance Corp)

2009: More standardisation mainly in valuation with the Big Bang (Apr) and Small Bang (Jul) Protocols.

Later in 2004 they were merged to form iTraxx for Asia and Europe, and the DJ CDX for North America.

1999/2000: The market opens to more parties. We see some first real volume from IDBs










Mar 2003: ISDA definitions become the market standard.

Oct 2003: IBOXX and TRAC-X CDS Indexes are created.

1998: first basket trades

Jun 2005: ISDA creates definitions for CDS on ABS

Nov’10: The Chinese market opens for Credit Mitigation Instruments with CRMA and CRMW.

evolution of cds global growth 2001 2012
Evolution of CDS: Global Growth (2001~2012)

Source: ISDA Market Survey (2001~10), DTCC (2010~12)

challenges in the asian market
Challenges in the Asian Market
  • Negative Mindset on CDS
  • Pricing

- Lack of Default Statistics/ Empirical Data

  • Market Liquidity

- Reference vs. Deliverable Obligations

- Standardisation of Contracts

  • Settlement issues

- Proper legal framework

- Central clearing

- Determination Committee

challenges in the asian market1
Challenges in the Asian Market
  • A Negative Mindset
    • CDS at market inception = Hedging Tool
    • implies exposure to highly risky credits
    • As market evolves CDS becomes THE primary tool to take a position on a Credit
    • a very active market in CDSs written on credits in which neither the buyer nor the seller of protection believes there is the remotest possibility of default
  • China: Credit Risk Mitigation Instruments
    • Hesitation to use the term “Default”
    • Hesitation to expose volume information (NAFMII)
challenges in the asian market pricing
Challenges in the Asian Market : Pricing
  • Lack of Empirical Data/Default Observations
  • Asia (ex-Japan)*

*Asia refers to Cambodia, China, Fiji, Hong Kong, India, Indonesia, Korea, Malaysia,Marshall Islands, Mongolia, Pakistan, Papua New Guinea, Philippines, Singapore, South Korea, Sri Lanka, Taiwan, Thailand, and Vietnam

  • 48 defaults in 17 years
  • Japan: 3 CDS defaults since 2003
challenges in the asian market pricing1
Challenges in the Asian Market : Pricing
  • Lack of Empirical Data/Default Observations
  • India
  • Fitch India National Ratings 2010 Transition and Default Study
  • 18 defaults in 11 years
challenges in the asian market liquidity
Challenges in the Asian Market : Liquidity

Opaque Market

  • Banks Price approximately 2,500 Single Names
  • The liquid part of the Market is no more than 1,000.
  • Many do not price daily, most do not have pricing in the full term structure.
  • 5Y Contracts are by far the most liquid.
  • Reference vs. Deliverable Obligations (CRMs)
  • CRMs specify a deliverable obligation
  • No naked positions
  • Standardisation of Contracts
other challenges settlement issues
Other Challenges: Settlement issues

Proper legal framework

  • Weak bankruptcy laws in Asia
  • E.g. Takefuji

Central Clearing

  • transparency of CDS volumes trading
  • DTCC has 98%* visibility

Determination Committee

*source: ISDA media comment Nov 2011


Credit Default Swaps – IndiaFIMMDA – PDAI 13th Annual Conference 2012DATE: 27th January 2012H. Jayesh Founder Partner, Juris Corp

eligible participants
Eligible Participants
    • Market Makers
    • Commercial Banks
    • Primary Dealers
    • NBFCs#
  • Mutual Funds*
  • Insurance Companies*
    • Users
  • Market Makers
  • Housing Finance Companies
  • Provident Funds
  • Listed Companies
  • FIIs

* Subject to permission from their respective regulators

# Currently only as Users

user restrictions obligations
User Restrictions / Obligations
  • Only Indian Resident or Registered FIIs
  • Only hedging / buy protection
  • No naked CDS
    • Hold Reference Obligation or Unwind
    • CDS protection value≯FV of Reference Obligation
    • CDS tenor ≯Reference Obligation maturity
  • Submit auditor / custodian certificate of holding underlying bond when entering into / unwinding the CDS contract
user restrictions obligations contd
User Restrictions / Obligations …contd
  • On selling the Reference Obligation:
    • Assign CDS with the Reference Obligation or
    • Negotiate termination
    • Hardwiredtermination:
      • Uncovered CDS Event occurs within 10 Business Days
      • CDS terminated and Buyer pays the Seller CDS Transaction Costs (one way payment only)
      • Failure / Non compliance - Not an Event of Default or Termination Event
  • Cannot enter into an offsetting trade
reference obligation
Reference Obligation
  • Must satisfy ALL of the following at ALL times:
    • Bond denominated in INR
    • Direct obligation of the Reference Entity (no guarantees)
    • Dematerialised format
    • Freely transferrable without any contractual, statutory or regulatory restriction (including SEBI lock-in requirements)
reference obligation contd
Reference Obligation …contd
  • Any ONE of the following:
    • Listed
    • Rated by any Rating Agency
    • Obligation in respect of which the Reference Entity is an SPV that is an Affiliate of an Infrastructure Company
reference obligation contd1
Reference Obligation …contd
  • Must NOT be:
    • Short Term Instrument (commercial paper)
    • Asset-Backed Security
    • Convertible Obligation
    • Exchangeable Obligation
    • Interest Receivable
    • Puttable or Callable
  • Consequences of failing Reference Obligation criteria on Trade Date (or date of identifying Substitute Reference Obligation) - Terminate at zero cost (no MTM, no Event of Default or Termination Event)
deliverable obligations
Deliverable Obligations
  • User MCA
    • Reference Obligation Only (consistent with User obligation to hold the Reference Obligation)
  • Market-maker MCA:
    • Reference Obligation
    • Deliverable Obligation Category: Bond
    • Deliverable Obligation Characteristics: Not Subordinated, Not Sovereign Lender, Not Contingent, Transferable, Maximum Maturity (30 years) and Not Bearer
    • Denominated in INR and dematerialised format
    • Other than:
      • Short Term Instruments (commercial paper)
      • Asset-Backed Securities
      • Convertible Obligations
      • Exchangeable Obligations
      • Interest Receivables
      • Puttable or Callable obligations
  • Reference Obligation
  • Obligation Category: Bond or Loan
  • Obligation Characteristics:
    • Not Subordinated and Not Sovereign Lender
  • Excluded Obligations
    • Short Term Instruments (commercial paper)
    • Interest Receivables
  • No guarantees
  • No currency limitations
credit events
Credit Events
  • Restructuring (Article 4.7) – substituted clause:
  • BIFR decision
  • Reference Entity is declared a Relief Undertaking or is granted statutory protection from its creditors or from enforcement of any monetary claims
  • Reference Entity is referred to Corporate Debt Restructuring

Credit Default Swaps – IndiaFIMMDA – PDAI 13th Annual Conference 2012DATE: 27th January 2012Jacqueline ML Low Senior Counsel, Asia - ISDA

Determinations of Indian DC are legally binding on anyone who uses the Market-maker MCA or User MCA.

Representation on DC.

7 Market-maker FIMMDA members:

2 Public Sector Banks.

2 Private Indian Banks.

2 Foreign Banks.

1 Non-Banking Financial Company.

4 User members.


International experience.

Indian Determinations Committee

Between Indian and offshore CDS.

Between Market-maker and User CDS.

Ref Ob CDS for User.

Physical Settlement Period.

Uncovered CDS Event.

Substitution Trigger Event c/f Substitution Characterisation Event.

Basis Risk


Credit Default Swaps – IndiaFIMMDA – PDAI 13th Annual Conference 2012DATE: 27th January 2012Mr. Vaidya Nathan Director, Quantum Phinance

credit default swap
Credit Default Swap

A privately negotiated, off balance sheet agreement that explicitly transfers credit risk from one party to another

Buyer of CDS protection need not own the defaulted asset in order to receive compensation

Buyer of protection need not suffer an actual loss to receive compensation


Credit Default Swaps

Vaidya Nathan


credit default swaps market completion
Credit Default Swaps market completion

Bond / Loan

Asset Swap

Credit Default Swap

Credit Risk

Credit Risk

Credit Risk

Funding Risk

Funding Risk


Risk Free Rate

Vaidya Nathan


cds in the context of financial markets growth
CDS in the context of financial markets growth

New applications expanding financial instruments use

New products are

emerging to span

second & third

generation products

Asset classes getting extended beyond traditional markets


Vaidya Nathan


role of cds
Role of CDS

Uses of Credit Default Swaps

Uses of Credit Default Swaps

Hedge, transfer and/or mitigate credit exposure

Synthetically create loan-bond; alternative to equity derivatives

Decompose and separate credit risks embedded in financial instruments


Generate leverage or yield enhancement

Proactively manage credit risk on a portfolio basis

Manage regulatory capital ratios

Vaid Nathan


cds isolate and transfer credit risk
CDS isolate and transfer credit risk
  • Broad definition
    • bilateral financial contract which allows specific aspects of credit risk to be isolated from the other risks of an instrument, and passed from one counterparty to another


60 bps



6.60 % yield

FX, Interest Rate

On-balance sheet

Off-balance sheet

Vaidya Nathan


efficiency gains arising from disaggregating risk through cds
Efficiency gains arising from disaggregating risk through CDS

Auctioneer sells a number of risks, each to the highest bidder



Vaidya Nathan


applications for cds in the global market
Applications for CDS in the global market

Motivations for using Credit Default Swaps

1. Trading/ market making

2. Product structuring

3. Hedging trading instruments

4. Active portfolio/ asset management


5. Management of economiccapital

6. Management of regulatory capital

7. Management of individual credit lines

Vaidya Nathan


breakdown of market participation
Breakdown of market participation

Market Composition


Vaidya Nathan


credit derivatives by region
Credit Derivatives by region

Credit Derivatives by region


Vaidya Nathan


global credit derivatives product usage
Global Credit Derivatives Product Usage


Vaidya Nathan


global credit derivatives product usage1
Global Credit Derivatives Product Usage

Global Credit Derivatives Product Usage



Vaidya Nathan

credit rating of underlying reference entity in cds
Credit rating of underlying reference entity in CDS

Credit rating of the underlying reference entity


Vaidya Nathan


tenor distribution of cds
Tenor distribution of CDS



Vaidya Nathan


market constraints
Market Constraints

Constraints in using Credit Default Swaps

1. Lack of client knowledge of the product

2. Regulatory constraints

3. Systems / Infrastructure

4. Pricing – lack of data


5. Lack of agreed accounting conventions

6. Lack of homogenous documentation

7. Lack of market liquidity and depth

Vaidya Nathan



Credit Default Swaps – IndiaFIMMDA – PDAI 13th Annual Conference 2012DATE: 27th January 2012Mr. GauravPradhan MD & Head, Global Credit Trading, Deutsche Bank, Mumbai


Journey so far...

2011 – Capital adequacy guidelines released in November

First trade printed in December between ICICI and IDBI

2010 – Internal Group report in Introduction of CDS released in July

Detailed policy framework with discussion on international practices

2003 – 1st Draft Guidelines

Scope of allowing banks and financial institutions to use credit derivatives

2007– 2nd Draft Guidelines

To permit Banks and PDs to deal in single-name CDS. Kept in abeyance on account of global financial crisis

2011 – 3rd Draft Guidelines in Feb and Final Guidelines in May

Final guidelines published to be effective from October



Global Experience

  • RBI introduced CDS in the Indian market at the right time. It could draw upon the experience of the western world during the Financial Crisis of 2008 and incorporate important safeguards since the inception:
    • Avoid complexity: Products like CDOs, ABS, MBS not allowed
    • Curb Speculative activity: Users allowed to only hedge long positing in cash bonds
    • Regulatory limits: Avoid excessive risk taking by putting limits like single name exposure, gross PV01 limits
    • Standardized contracts: Enable trade reporting; enable trde compression thereby reducing systemic risks on account of large number of open contracts
    • Regulatory oversight: Mandatory reporting of trades on central platform; Regulator can monitor activity of participants and avoid any misuse/ large concentration of risk
    • Central Clearing Counterparty: Important to avoid counterparty risk; Will be introduced when volumes pick up and viable to implement



Role of FIMMDA – So far

  • FIMMDA played a key role in developing the market infrastructure:
    • Documentation:
    • FIMMDA in liaison with ISDA and market participants helped in developing market standard documentation (MCAs)
    • Determinations Committee:
    • Scope and role of DC was defined; Initial list of DC members finalized
    • Market-Makers
    • Market maker volunteers were identified
    • Valuation Methodolgy
    • Methodology for daily valuation of CDS positions was developed. External vendor was identified and mandated with the task of polling/ publishing curves



Role of FIMMDA – Future

  • Next steps required for market to develop:
    • Activation of DC for continuous monitoring
    • Standardized Margining policy
    • Various supporting regulators like SEBI/ IRDA to evolve a framework allowing for participants like Insurance companies/ Mutual Funds/ FII
    • Central counterparty settlement
    • Support training and development requirements for banks – Front office/ Middle office/ Back office/ legal etc.



Market participants

  • Market Makers
  • Users



Mutual Funds

Insurance Cos




Banks and PDs have been permitted by their Regulator to be market-makers (Onus on them to ensure that the market develops)

Insurance cos/ MFs/ FIIs are yet to receive support from their respective regulators



Key Contributions

  • On behalf of FIMMDA, we would like to thank the market participants for their active involvement and contribution in making the product go live:
    • ICICI Bank
    • IDBI Bank
    • SBI
    • Central Bank of India
    • HSBC
    • Standard Chartered
    • Morgan Stanley
    • Barclays
    • Citi
    • JP Morgan
    • Bank of America
    • ICICI Securities Primary Dealership
    • Additionally we would like to thank the following agencies
    • Thomson Reuters, Markit, Bloomberg, Newswire18
    • ISDA
    • Juriscorp



Thank you!