31 October 2005
Key Points:
Participants in the credit derivatives markets may not be able to enter into novations of credit default swaps with most of the major credit derivatives dealers unless they have adhered to the ISDA 2005 Novation Protocol. The adherence deadline is 30 November 2005.
From 24 October 2005, participants in the credit derivatives and interest rate derivatives markets who are parties to the various Master Agreements published by ISDA will be able to benefit from the introduction of a new 2005 ISDA Novation Protocol.
The Protocol was launched on 12 September 2005 in response to the large and growing trade settlement backlog that the UK and US regulators have recently identified as a potentially significant source of operational risk in the derivatives market. This backlog is most acute with respect to credit and interest rate derivatives, which explains why the Protocol benefits are initially limited to these products only.
In response to the concerns articulated by the US regulators, 14 major credit derivatives dealers recently committed to the Federal Reserve Bank of New York to automate future credit derivatives trades and operational processes and clear existing confirmation backlogs by June 2006. The dealers also outlined the steps they would follow in order to meet these commitments.
Importantly, these steps include a pledge by the participants not to accept any novation of a credit derivative unless the transferor has adhered to the Protocol or they receive the prior written consent of the remaining party, as contemplated by the terms of the relevant ISDA Master Agreement.
The current number of adherents to the Protocol is over 700. Most major U.S. based dealers in the OTC derivatives markets have signed, including Citigroup Global Markets, ABN Amro, JPMorgan Chase Bank, Morgan Stanley, Nomura and Barclays Capital.
Application of Novation Protocol
The Protocol is designed for participants in the OTC derivatives market that have entered into covered transactions (credit derivatives and interest rate derivatives) governed by an ISDA Master Agreement. Adherence to the Protocol is open to both ISDA members and non-members.
When a party wishes to novate a transaction to a third party, section 7 of the ISDA Master Agreement currently requires the prior written consent of the remaining party to the novation. The Protocol sets out an agreed process by which the transferor, the transferee and the remaining party will communicate to obtain and provide this written consent, using one of the specified electronic means.
If the remaining party does not consent in writing by 6.00pm (in the location of the transferee), the original transaction remains in place and a new trade will be booked between the intended transferor and the transferee. The parties also commit to exchange a novation confirmation confirming the details of the novated trade.
Deadline for adhering to the Novation Protocol and Implementation Date
The protocol will be open for adherence until 30 November 2005. Market participants can sign up to the Novation Protocol by sending an Adherence Letter to ISDA by email to protocol@isda.org.
Parties who adhere to the Protocol on or prior to October 24 2005 will implement those procedures with respect to other adhering parties from and after October 24 2005. Parties who adhere to the Protocol after October 24, 2005 will implement those procedures with respect to other adhering parties when adherence of both parties to the Protocol is effective.
ISDA will provide stand-alone language for parties to incorporate into their ISDA Master Agreement for Master Agreements entered into after the November 30 deadline for the Protocol.
For further information please consult the ISDA website, www.isda.org.
For further information, please contact Louise McCoach.
