Big Bang arrives for credit default swaps industry

--acution process will be hardwiresd into all CDS contracs, if defaults, outstanding claims will be settled according to pre-designated procedrue rather tah nin an ad hoc manager. --a determination commitee will decide whether a company ddfault has triggered --when a CDS contrct was purchased, the invesotr will be protected, no more time lag By Nicole Bullock and Michael Mackenzie in New York and,Gillian Tett in London. Published: April 8 2009 03:00 Last updated: April 8 2009 03:00 The credit derivatives industry faces a Big Bang today and yesterday participants were rushing to sign up to a new protocol designed to counter the intense criticism that has emanated from political and regulatory quarters over the industry's alleged role in contributing to the market crisis. At the eleventh hour, dealers and investors besieged the International Swaps and Derivatives Association ahead of implementing a self-styled "Big Bang" protocol. This protocol, which has been adopted by some 1,500 players - mostly in recent days, if not hours - aims to introduce more consistency into the credit default swaps market by imposing a uniform procedure for settling CDS contracts when a company goes into default (see box). It also tries to impose more standardisation by introducing set coupons for contracts - a measure that will initially be limited to the US, but could later spread into Europe. "The benefit of the Big Bang is to facilitate the migration of trades to a central clearing counterparty (CCP)," said Brian Yelvington, senior macro strategist at CreditSights. "Every change made to the contracts makes them more suitable for a CCP - so broadly, the market should benefit from having that risk mutualised and having a central repository for trade data." Jason Quinn, a director in credit trading at Barclays Capital, said there was some trepidation in the industry about the mechanics of changing the way the CDS contracts are traded in the US. He added that the industry has automated some key components of the switch and firms like Barclays have been working with investors for months to help them prepare for the changes. In the wake of last year's brutal financial turmoil, the protocol will reorganise how credit derivatives contracts work around the world. And while the details of these measures are highly complex and technical, the essential aim is to put the industry on a more robust footing - and show that the scale of outstanding risk is far smaller than politicians initially thought. Efforts are also intensifying to put CDS trades through a centralised platform in a bid to reduce counterparty risk - an endeavour which becomes much easier once standardised contracts are in place. The Intercontinental Exchange, for example, is running one clearing system in tandem with other banking groups, and has already managed to clear over $60bn worth of contracts. Last, but not least, initiatives are intensifying to "tear up" (or cancel) outstanding CDS contracts which offset each other. This week Trioptima, for example, will announce that it has "netted" another $5,500bn contracts in the first quarter. As a result, the outstanding size of the market currently appears to be shrinking in size (see chart) - a trend industry leaders hope will, in itself, help allay political concern. Raf Pritchard, chief executive officer at TriOptima North America said: "The big bang protocol is compelling the compression of a variety of different instruments as banks look to reduce their risk." Whereas dealers were somewhat reluctant in the past to reduce their outstanding derivatives exposure, the increased attention by regulators and balance sheet constraints at banks has heralded a big change in attitudes. Optimists in the industry insist that these measures should calm the critics of the CDS world. Last year fears were rife that the CDS sphere could pose a systemic threat. In the event, however, the CDS market continued trading during the financial crisis - and contracts written on Lehman Brothers and other bankrupt groups have hitherto settled smoothly. Pessimists, however, say that it is still far from clear that the measures are dramatic or speedy enough to allay all attack. One key reason why the industry has been so slow to adopt infrastructure changes until now is that ISDA has traditionally tended to be dominated by bankers who work on the trading side of the business. Dealers had every incentive to keep the market opaque and bespoke, which boosted margins - and profits, while downplaying infrastructure issues. Thus, when groups such as BlueMountain Capital, a large hedge fund, have campaigned for change in the past, they have encountered resistance. "The buyside will be a very significant part of what we do going forward in a more formalised manner," says Robert Pickel, chief executive officer at ISDA. The US Federal Reserve also seems determined to hand more power to investors. At a meeting of the key CDS players last week, for example, New York Fed officials insisted on including non-bankers . As the industry becomes more commoditised, it could well slash margins for the banks. The transformation of contracts to meet the new standards, or to simply "tear up" deals, will generate additional costs, which some banks have not budgeted properly for. If the CDS sector continues to expand, that decline in margins might be offset by a rise in volumes. The interest rate swaps business, for example, continues to generate healthy profits for some banks, even though it has become commoditised in recent years. But judging whether the market will continue to expand remains extremely hard - not least because the politics of regulation remain wildly volatile, in the CDS sphere as everywhere else.