Message-ID: <21311715.1075859802614.JavaMail.evans@thyme> Date: Wed, 2 May 2001 05:53:00 -0700 (PDT) From: smarra@isda.org To: jennifer@kennedycom.com, tmorita@isda.org, rainslie@isda.org, yoshitaka_akamatsu@btm.co.jp, shigeru_asai@sanwabank.co.jp, kbailey2@exchange.ml.com, douglas.bongartz-renaud@nl.abnamro.com, brickell_mark@jpmorgan.com, henning.bruttel@dresdner-bank.com, sebastien.cahen@socgen.com, scarey@isda.org, joshua.cohn@allenovery.com, mcresta@cravath.com, daniel.cunningham@allenovery.com, mcunningham@isda.org, jerry.delmissier@barclayscapital.com, shawn@blackbird.net, evangelisti_joe@jpmorgan.com, francois@us.cibc.com, tim.fredrickson@ubsw.com, gilbert_adam@jpmorgan.com, goldenj@allenovery.com, mark.e.haedicke@enron.com, fwhx9396@mb.infoweb.ne.jp, jhb1@bancosantander.es, quentin_hills@hk.ml.com, yhoribe@isda.org, milphil@gateway.net, skawano@isda.org, hiroyuki_keisho@sanwabank.co.jp, damian.kissane@db.com, kazuhiko_koshikawa@sanwabank.co.jp, robert.mackay@nera.com, markb@cibc.ca, marjorie.b.marker@us.arthurandersen.com, lmarshall@isda.org, donna.matthews@ubsw.com, mengle_david@jpmorgan.com, tom.montag@gs.com, dmoorehead@pattonboggs.com, jonm@crt.com, yasumasa.nishi@ibjbank.co.jp, dennis.oakley@chase.com, losullivan@isda.org, ernest.patrikis@aig.com, rpickel@isda.org, maria.rosario@db.com, arothrock@pattonboggs.com, rryan@isda.org, maurits.schouten@csfb.com, charlessmithson@mindspring.com, ksumme@isda.org, teruo.tanaka@ibjbank.co.jp, steve_targett@nag.national.com.au, h.ronald.weissman@us.arthurandersen.com, twerlen@cravath.com, dpd@aurora.dti.ne.jp, chi-wing.yuen@aig.com, apapesch@isda.org, nlim@isda.org, kdhulster@isda-eur.org, esebton@isda-eur.org, cirens@isda-eur.org, rmetcalfe@isda-eur.org, mhitchcock@isda-eur.org, kengelen@isda.org, pmartinez@isda.org, steven@kennedycom.com, pwerner@isda-eur.org Subject: ISDA PRESS REPORT - MAY 2, 2001 Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: Scott Marra X-To: "'jennifer@kennedycom.com'" , Tomoko Morita , Ruth Ainslie , "'Yoshitaka Akamatsu'" , Shigeru Asai , Keith Bailey , Douglas Bongartz-Renaud , Mark Brickell , Henning Bruttel , Sebastien Cahen , Stacy Carey , Josh Cohn , "'Marjorie Cresta (Cravath)'" , Daniel Cunningham , Mary Cunningham , Jerry del Missier , "'Shawn Dorsch (Derivatives Net)'" , "'Joseph Evangelisti (JP Morgan)'" , "'George Francois (CIBC)'" , Tim Fredrickson , "'gilbert_adam@jpmorgan.com'" , Jeff Golden , Mark Haedicke , "'Tsuyoshi Hase'" , Jose Manuel Hernandez-Beneyto , "'Quentin Hills'" , Yasuko Horibe , "'Michael Iver'" , Shigeki Kawano , Hiroyuki Keisho , Damian Kissane , Kazuhiko Koshikawa , Robert Mackay , Robert Mark , Marjorie Marker , Louise Marshall , "'Donna.Matthews@ubsw.com'" , "'David Mengle (JP Morgan)'" , Thomas Montag , Don Moorehead , Jonathan Moulds , "'Yasumasa Nishi (IBJ)'" , Dennis Oakley , "Liz O'Sullivan" , Ernest Patrikis , Robert Pickel , "'Maria.Rosario@db.com'" , Aubrey Rothrock , Rosemary Ryan , Maurits Schouten , "'Charles Smithson'" , Kimberly Summe , Teruo Tanaka , Steve Targett , "H.Ronald Weissman" , Thomas Werlen , "'Shunji Yagi (Sanwa)'" , "'chi-wing.yuen@aig.com'" , Angela Papesch , Nellie Lim , "Katia d'Hulster" , Emmanuelle Sebton , Camille Irens , Richard Metcalfe , Michelle Hitchcock , Karel Engelen , Pedro Martinez , Steve Kennedy , Peter Werner X-cc: X-bcc: X-Folder: \Mark_Haedicke_Jun2001\Notes Folders\All documents X-Origin: Haedicke-M X-FileName: mhaedic.nsf ISDA PRESS REPORT - MAY 2, 2001 * ISDA backs push for legal certainty - IFR * Canadian Central Bank Downgrades Forecast for 2001 Economic Growth - BNA * SEC Urges More Use of Fair - Value Pricing - The Wall Street Journal * Small frys curbed - Business Standard * The difficulty of defining a default - Euromoney Magazine ISDA backs push for legal certainty IFR - April 28, 2001 The International Swaps and Derivatives Association is backing an international movement aimed at increasing the legal certainty of collateralised transactions. With cross-border collateralisation growing, lack of clarity over which jurisdiction applies to dealings in indirectly-held securities presents legal risks, said Kimberly Summe, assistant general counsel at ISDA in New York. ISDA has joined with 16 other international organisations and 119 legal experts to put together a proposal aimed at recognising the law of the location of the intermediary maintaining the account to which the security is credited as the applicable law in collateralised transactions. They hope to have a text for adoption within a year. The current Basle bank capital reform process is putting collateral in the spotlight. "lf a bank views collateral as difficult to get hold of, then it will value it less. And it may need to increase reserve requirements with respect to the loan secured by that collateral." said Morgan Burkett, chief legal officer at Cygnifi Derivatives Services in New York. Canadian Central Bank Downgrades Forecast for 2001 Economic Growth BNA - May 2, 2001 OTTAWA--The greater than anticipated economic slowdown in the United States has forced a downward reassessment of Canada's economic growth prospects in 2001 to between 2.0 and 3.0 percent, the Bank of Canada said May 1. The U.S. economy is now projected to grow by between only 1.0 and 2.0 percent during 2001, even with the boost that will be provided by the expected growth of between 2.0 and 3.0 percent during the second half of the year, the central bank said in its semi-annual Monetary Policy Report. The bank had indicated in a Feb. 6, 2001, update of its last semi-annual report that it expected the Canadian economy to grow by about 3.0 percent during 2001, based on U.S. growth of 2.0-2.5 percent. "It now looks as if growth over the first six months will average between 1.25 and 2.25 percent. For the second half of the year, we see growth picking up significantly to between 2.5 and 3.5 percent," the latest report said. "The pace of activity in 2002 is expected to be somewhat stronger than in the second half of 2001, with the economy expanding at a rate slightly above the Bank's estimate of potential output growth of 3.0 percent." Meanwhile, the anticipated re-emergence of excess supply in the Canadian economy will contribute to continued downward pressure on core inflation during the remainder of 2001, and core inflation is expected to average slightly less than 2.0 percent for the remainder of 2001, then to increase to about 2.0 percent by the end of 2002, the Monetary Policy Report said. Increases in the overall Consumer Price Index are expected to remain volatile over the next few months, but then to also fall to about 2.0 percent by the end of the year if world energy prices remain near current levels, it said. The central bank stressed that the main risk to its projections for the Canadian economy remain the timing and strength of the projected resurgence of the U.S. economy, and the report noted that it will continue to monitor developments closely and make further adjustments to its trend-setting Bank Rate as necessary. "For example, if consumer and business confidence in the United States does not improve, this could lead to weaker consumption and investment spending," it said. "Another development that the Bank will have to watch closely because of its possible implications for aggregate demand and inflation in Canada is the shift in international financial market sentiment that has led to a strengthening of the U.S. dollar against the Canadian dollar and other currencies." SEC Urges More Use of Fair - Value Pricing The Wall Street Journal - May 2, 2001 By Judith Burns U.S. mutual funds can't rely on stale prices when calculating the value of their portfolios, a senior Securities and Exchange Commission attorney said. In a letter to the Investment Company Institute, a leading fund-industry group, Douglas Scheidt, general counsel of the SEC's investment-management division, said funds should be on the lookout for events that might require them to use fair - value prices for certain securities, rather than relying on the last quoted price. Mr. Scheidt said funds can't ignore major changes affecting pricing that occur after trading closes but before the calculation of the net asset value of the securities in fund portfolios. Mutual funds typically compute their NAV once a day, after the close of securities trading in major U.S. markets, using readily available quotations. When that isn't possible, funds must base calculations on the fair value of a security. When calculating fair-market value, the SEC said funds should use appropriate methods to determine the price they might reasonably expect to receive in a current sale. It recommended funds compare fair-market pricing results with the next-day opening prices or actual sales prices to refine their pricing techniques and avoid using market quotes from dealers and pricing services that prove unreliable. "Funds that automatically use market quotations to calculate their NAVs without first verifying that the market quotations are readily available cannot be assured that the resulting NAVs are accurate," Mr. Scheidt wrote in his letter dated Monday. Accuracy could be called into question if a fund ignores developments in markets such as Tokyo or Hong Kong, which close 12 to 15 hours ahead of the U.S. closing, the SEC attorney said. Market swings, natural disasters, terrorist activity or a major change in government or policy could have dramatic effect on foreign securities prices. If a fund determines a significant event has occurred after a market closes that would affect the value of a security it holds, the fund must use " fair value pricing methodology," rather than the closing price, when valuing its portfolio, said Mr. Scheidt. "Funds can't just put their head in the sand," Mr. Scheidt said yesterday in an interview. The ICI said it plans to distribute Mr. Scheidt's comments to its members. "The letter will be useful in providing guidance to the funds on this matter, " ICI spokesman John Collins said. Fair - value pricing isn't limited to non-U.S. securities. In cases where trading in a U.S. security is halted, or there is a significant development after an early market close, funds should no longer rely on the closing price or last quotation when calculating their NAV, according to the SEC staff letter. On the other hand, where market quotes are deemed reliable, it said funds must continue to use them and can't switch to fair - value pricing. Fair - value pricing has been controversial for funds in recent years. In the fall of 1997, there was an outcry from investors who complained they bought and sold shares without realizing some fund companies, including Fidelity Investments, relied on fair - value pricing after Asian markets swooned. Fidelity calculated an increase in the value of its Hong Kong and China fund using fair-market pricing. Investors could be harmed if a fund doesn't use fair - value pricing, since it could generate arbitrage activity that dilutes shareholder value, the SEC letter noted. If the fund's NAV doesn't reflect up-to-the-minute changes, shares could be overpriced, benefiting investors who sell their stake while harming those who overpay to acquire shares. Conversely, if the fund is underpriced, sellers would suffer at the expense of buyers. " Fair - value pricing can protect long-term fund investors from short-term investors who seek to take advantage" of such situations, Mr. Scheidt said. Additionally, the SEC urged funds to provide investors with more information on when and how they will use fair - value pricing, saying "plain English" disclosure could reduce shareholders' complaints about the practice and discourage arbitrage activity. Small frys curbed Business Standard - May 2, 2001 By Sangita Shah The introduction of individual stock futures and options to replace the carry forward system will drive out the small retail investors from the stock markets, market sources said. According to market participants, while derivatives as instruments have always been an alien system to the Indian market, the technicalities involved will leave domestic investors bewildered. The introduction of index futures in June 2000 can be termed as anything but successful. This can be proved by the fact that the average daily volume of sensex futures has not crossed Rs 10 crore. Even Nifty futures, which has performed better in terms of liquidity, has barely registered an average daily volume of Rs 12 crore. This is a fraction of the cash market turnover of Rs 5,000 crore collectively, in a stable market. "Lack of understanding as to how the derivatives in stock markets are to be operated is the major roadblock, in the success of the futures and options market in our country," Bhavin Shah, a derivatives trader at a domestic firm said. In fact, even the LC Gupta Committee has noted in its report in March 1998 that " derivatives are not always clearly understood. A few well-publicised debacles (sic) involving derivatives trading in other countries has also created widespread apprehensions in the Indian public's mind." While economic literature recognises the efficiency enhancing effect of derivatives on the economy in general and the financial markets in particular, the Committee felt the need for educating public opinion, as also the need to ensure effective regulatory checks. "It is worth mentioning that while regulatory checks have been implemented, it has failed to educate public opinion. Under the circumstances, it is probably high-handedness on the part of the authorities to thrust upon them an alien system without giving an opportunity for smooth transition," a fund manager said on conditions of anonymity. However, the fact should also be considered that if futures and options in individual stocks are introduced in the country, India will be among the handful of global exchanges which have these systems. The problem is compounded by the fact that there are few international precedents for India to draw on in the matter of options and futures in individual stocks. The difficulty of defining a default Euromoney - April 2001 It's not difficult to see why the market is so taken with credit default swaps. For the protection buyer, they are a quick and easy way for investors worried about a particular credit risk - whether originally taken on via bonds, loans, ~ trade notes, or derivative counterparty exposure - to gain reassurance without having to dispose of assets. For sellers of protection, default swaps provide the opportunity to buy into sectors to which they may have little or no exposure, while avoiding the need to make a large capital investment up front. The buyer pays a premium to the seller in return for an agreement that, if a default occurs, the seller ~ pays a sum equal to the value lost and assumes _ ownership of the defaulted assets. For their part, dealers enthuse about being able to amalgamate limited liquidity in different parts of the market and convert it into a readily tradable instrument. "One of the big advantages of credit default swaps is that they are in pure derivative form," says Glenn Barnes, global co-head of credit derivatives at Merrill Lynch. "It's not like credit insurance where you have to suffer a loss before you get paid." Credit default swaps have quickly become ~ the largest component of the credit derivatives market, making up over two-thirds of global business. According to Merrill Lynch, the credit derivatives market accounted for $893 billion of notional value in 2000, a figure estimated to top $1.58 trillion by 2002. "Derivatives are now absolutely central to the whole credit benchmark," says Tim Frost, European head of credit derivatives at JP -Morgan. "Bond issues cannot be priced without knowledge of credit swap prices." While the threat of a bear market lingers, -credit default swaps can only grow in popularity as investors seek to insulate themselves against risk. "Up until three years ago, the -only liquid protection from risk available to bond investors was to -. go short on bonds and hope they got cheap enough to buy before they had to deliver," says Gordon Black, a -managing director in credit derivatives at Bear Stearns. However, because the credit default swap market is now taking centre stage, the structure of swap agreements is coming under much closer scrutiny. At the heart of the debate is the question how to define a credit event. In 1999, reacting to continued confusion in the market over the issue, the International Swaps & Derivatives Association (ISDA) published a list of conditions, each of which is sufficient on its own trigger a swap agreement. These credit events are bankruptcy, failure to pay, restructuring repudiation or moratorium, obligation default and obligation acceleration. At the time of publication, ISDA stated that these definition "were critical to the growth in demand fro credit derivative transactions. For a while, this kept market participant quiet. Although most felt that the arrangement was by no means perfect, they were happy to use ISDA's list as the basis of their credit default swap contracts. Having a blueprint for swap agreements attracted greater numbers of investors with no previous experience of default swaps, and liquidity boomed. But it wasn't long before the flaws in the plan began to surface. At the end of 2000, following a year of catastrophic results and event risk, US-based financial-services company Conseco restructured over $~ billion of debt. With the agreement of its banks, it extended the maturity of its bonds and loans until the end of 2003. Under ISDA rules, this triggered default and banks that had written protection for parties exposed to Conseco found themselves having to pay out. "Initially, we were fairly confident about ISDA including restructuring instead of the old 'material change'. We saw it as a step on the road to default," explains Black. "But people failed to recognize at the start that restructuring is not the same as default. You can't demand par value in the case of a default. This exposed the seller not only to credit risk, but market risk as well." In response to growing dissatisfaction with ISDA's guidelines, some market participants have gone about simplifying matters unilaterally. Dealers at a number of major US houses have decided to remove restructuring from the list of credit events included in credit default swap contracts. There is a liquid market for these swaps in the US, which trade at a discount to those with a restructuring clause. Other institutions have attempted to establish a market in swaps that carry a more limited definition of default. Enron, an energy trader that is also a large dealer in credit markets, is trying to build a market in pure bankruptcy contracts, where bankruptcy is the only event that can trigger payment. Regulators are warning investors to pay particular attention to the contract when they enter a credit default swap deal. Even banks aren't immune from confusion. Last month it emerged that UBS Warburg was suing Deutsche Bank over an unpaid obligation. UBS bought protection from Deutsche on Armstrong World lndustries, which meant that if AWl defaulted on its payment or went bankrupt, Deutsche would have to pay UBS $so million. In December, A\XTI filed for bankruptcy but in the meantime it had undergone a reorganization and created a holding company. So when UBS applied for payment from Deutsche, the German bank refused to pay on the grounds the name on the contract didn't match the name of the entity that had defaulted. The dispute nearly ended up in court. In London in February at Euromoney Institutional Investor's International Bond Congress, David Clementi, deputy governor of the Bank of England, voiced concern about the rapid growth of the credit derivatives market. "It is intrinsically more difficult to standardize the definition of a credit event compared with that of a price or interest rate - the underlying for most other derivative products," he said. "Market participants will therefore have to pay even greater attention to documentation." It's all in the contract Credit-rating agency Moody's Investors Service, too, has expressed concern that investors don't always know what they are buying. "When investors enter an agreement with a derivatives trader, they're talking to someone who works with these products full time. So they're getting into something fairly technical with a dealer who knows much more about the subject than they do," says Isaac Efrat, managing director in the structured finance department at Moody's. "Investors always enter the market from the same direction, of wanting to sell protection, whereas dealers tend to hedge everything. The risk has to go somewhere and my guess is that it's going to investors," he continues. Bankers, unsurprisingly, dispute this, saying that the rating agency is underestimating investors' knowledge of the structures. "Frankly, I think people do understand the risks very well," says Barnes at Merrill Lynch. "Some of the most recent entrants to the market, pension funds and hedge funds, have quickly picked up how credit default swaps work." Others say that the whole point ~f default swaps is the exposure to risk. "Moody's is raining on the parade," says a credit derivatives trader. "Credit default swaps-are supposed to synthetically create the risk profile of a bond. The buyer acquires the risk and is paid for it." But most admit that there are kinks in the market that need ironing out. Most of these are to do with one particular type of credit event. "Restructuring is where things come unstuck," says a market participant. "The current restructuring clause in credit protection is more in favour of the buyer," says Antonio di Flumeri, director of credit derivatives at Deutsche Bank. He believes that a company's restructuring shouldn't give rise to a default. "Banks holding loans and protection have the opportunity to realise a windfall gain by restructuring those loans to trigger the swap, then delivering a cheaper asset to the seller of protection," di Flumeri says. Barnes agrees. "From the dealer's perspective, it isn't fair if the holder of the asset consents to the restructuring of a loan but this then triggers a credit event payment," he says. "This gives the bank Without such protection, financial institutions would lose out on capital relief. An alternative, which has found more favour among bankers, is to place restrictions on what is deliverable in the case of a restructuring. Under present arrangements, if a bank sells a five-year protection on a loan or bond with the same length maturity and that debt subsequently needs to be restructured, the original lending bank can agree to any terms it chooses. It might, for example, allow a company to extend its debt to a maturity date of 30 years in the future. Because a restructuring has taken place, that bank can then exercise the default swap and the seller of the protection ends up owning 30-year debt. This can be a real problem if that investor has been marking the bond or loan to market. "What is cheapest for the buyer of protection to deliver may cause problems for those who have sold protection," says Black. The answer may be for ISDA to set a limit to the time over which debt can be restructured, perhaps restricting it to the same maturity as the original loan, or two or three years beyond it. This would limit bankers' discretion and help redress the balance. "The question is, can we convince the banks that this isn't limiting their ability to restructure?" asks one trader. "They're going to say: 'What, you're telling me I can only restructure over two years? That's not much of a restructuring'. They'll ask for 10, we'll say three, maybe we'll settle on five." Whatever the outcome of this debate - as Euromoney went to press ISDA had not yet announced its conclusions - it needs to be resolved quickly. "Everyone realizes that something has to give," says a credit derivatives trader. "This market has only existed for three years and there's only been any sort of meaningful liquidity for two. The last thing we want to do is shoot ourselves in the foot." Unless an agreement is reached soon, there's a real danger that the emergence of default swaps without restructuring in the US could lead to the establishment of a two-tier market. Certainly, the possibility of Europe excluding restructuring is a remote one, "I've tried to do credit default swaps without it a couple of times in Europe and it just doesn't work," says one derivatives trader. So that leaves it to the US to back down. Or does it? "European investors do often tend towards European names and the same situation occurs in the US and Asia," says a banker. "In theory, each jurisdiction could have its own treatment. This wouldn't be a disaster, but it would affect liquidity." Moody's Efrat says: "I can easily envision a day when there will be a wide range of credit default swap contracts determining what counts as a default." Stephen Selig, counsel at Baer Marks & Upham, goes further. There is no reason why contracts shouldn't be specific to particular deals, he says. "Unless I'm missing something, I really don't see why the scope of the protection, and what gives rise to a trigger of the swap, can't be part of the individual contract between the buyer and the seller. ISDA tries to cover every eventuality and all you get is a long and unreadable list of conditions." For the sake of practicality, not to mention liquidity, it seems likely that ISDA will come down on the side of a single set of criteria. "The market needs a standard product," says Black at Bear Stearns. "You don't want to have to compare documentation every time you do a credit default swap because different jurisdictions have different standards." Participants want to use credit default swaps for different purposes: some want to hedge receivables, others use them as a synthetic asset class and others still to hedge loans. So a blueprint is also essential to avoid exploitation of new entrants in the market. "At the limit, if everyone developed a contract which suited their own needs perfectly, there would be no trading at all," says Frost at JP Morgan. Opinions are divided on whether this debate is causing a slowdown in the credit default swap market. Says Deutsche Bank's Flumeri: "Volumes are the highest they have ever been so I don't think the debate is having a significant impact." But, according to another trader, "If there was a universally accepted contract for credit default swaps, volumes would explode." But whatever ISDA announces, this is likely to be some way off. "If people are expecting credit swaps to be as vanilla as interest rate swaps then they are sadly mistaken," says Frost at JP Morgan. "I expect to have retired before there is one standard contract that everybody around the world uses." Scott Marra Administrator for Policy & Media Relations ISDA 600 Fifth Avenue Rockefeller Center - 27th floor New York, NY 10020 Phone: (212) 332-2578 Fax: (212) 332-1212 Email: smarra@isda.org