Credit Default Swaps: The Vanilla Essence
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Orphaning
Orphaning
Foreword
Preface
A credit default swap snapshot
Parties and key players
Documentation and standard trading conventions
Credit risk period, scheduled termination date and termination date
Fixed amounts, floating rate payer calculation amount and initial payment amount
Qualifying guarantee and qualifying affiliate guarantee
Reference obligation
Subordination and the senior non-preferred supplement
Outstanding principal balance and due and payable amount
Obligations and deliverable obligations
Credit event overview
Bankruptcy
Failure to pay
Repudiation/moratorium
Restructuring and redenomination
Governmental intervention and contingent convertible capital instruments
Successor determinations
Publicly available information and eligible information
Notices
Business day terms and timing rules
Event determination date and settlement methods
Auction settlement
Cash settlement
Physical settlement
Physical settlement fallback procedures
Orphaning
Fixed recovery transaction and reference obligation only trade
Novation and early termination
Economic sanctions: compliance challenges
Disclosures and regulations
Conclusion: at the ‘Exit Checkpoint’
Appendix
References
26.1 INTRODUCTION
Having completed an examination of the key concepts that relate to a CDS transaction, in this part of the book our expedition moves on to explore four specific discussion topics that are integral to the trading of a CDS, beginning in this chapter with orphaning risk.
The chapter commences by describing what orphaning risk is and the events that magnify it. The concept of “frustration” within the context of a credit derivative transaction is further discussed, given the overlap between the events covered under the “no frustration provision” of the 2014 ISDA Credit Derivatives Definitions (henceforth the “2014 Definitions”; see International Swaps and Derivatives Association Inc. 2014b) and those that give rise to orphaning risk. The challenges in identifying and managing orphaning risk, including the impact of missed succession events, are also examined. In the concluding section, the correlation between the market’s perception of orphaning risk and the spread levels of a CDS transaction, including changes made to the constituents of a credit index as a result of diminishing liquidity in a traded reference entity, are highlighted.
26.2 ORPHANING RISK
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