Response To 4-18-2018 General Interest Question

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GENERAL INTEREST QUESTION: Should the DC reject or dismiss a general

interest question posed to the DC that purports to be interpretative but instead


seeks to fundamentally alter the purpose and scope of the Auction process?

This statement is submitted in connection with the General Interest Question


posted to ISDA on April 18, 2018 seeking an interpretation of Section 3.2(c) of the 2016 ISDA
Credit Derivatives Determinations Committees Rules (the “DC Rules”).1 The Determinations
Committee (“DC”) should reject or dismiss the April 18 General Interest Question because it
improperly seeks to institute Auction-specific terms outside the context of a pending Auction.
Accepting the premise set forth in the General Interest Question also would impose
inappropriate burdens on the DC, introduce uncertainty and risk into the DC determination
process, and run counter to the stated objectives of the ISDA CDS Auction process.

The General Interest Question purports to request the interpretation of the DC


Rules in the abstract, while in fact proposing new Auction-specific terms in the absence of a
Credit Event determination or pending Auction. In effect, the General Interest Question would
have the DC introduce a new Deliverable Obligation Characteristic—namely that Obligations
with a trading value the DC deems too low should be disqualified from an Auction. The General
Interest Question thus improperly asks the DC to establish Auction-specific terms outside the
context of a Credit Event or an Auction and should be rejected.

The General Interest Question also imposes an inappropriate burden on the DC.
For the DC to determine if specific Obligations would produce a “low” Auction Final Price, the DC
would be required to form a view as to the relative expected recovery values of the Reference
Entity’s outstanding obligations. The DC would become the arbiter of value, guess at the course
and result of an impending Auction, and thereby preempt and directly undercut the very
purpose of the Auction— to determine the expected recovery value of the Reference Entity’s
cheapest-to-deliver Deliverable Obligation in a transparent, market driven process. The
established highly transparent and tested Auction process enables market participants to settle
CDS positions efficiently based on a market-wide price following a Credit Event, and contributes
significantly to the functioning of the CDS market.

Moreover, in order to determine that a particular Obligation would produce an


“artificially” low Auction Final Price, the DC will need to engage in a time consuming and
possibly futile fact finding mission, something that it is not designed or equipped to do. To
effectively discharge the discretionary responsibility required under the new rule requested in
the April 18 General Interest Question, the DC would have to investigate and second-guess the
subjective rationale and state of mind of the Reference Entity and other market participants
without any objective guidelines. Indeed, the DC would have to definitively answer several
questions that are unlikely to have clear and objectively determinable answers such as: which
motivation will disqualify an Obligation? Which intent will be deemed acceptable behavior? The
endeavor would introduce considerable unpredictability and uncertainty into the CDS market
and the DC determination process, and leave market participants speculating about which

1
Capitalized terms used but not defined herein use the meanings given to them in the DC Rules or the
2014 ISDA Credit Derivatives Definitions, as applicable.
Obligations retroactively may be excluded from an Auction despite the fact that they otherwise
squarely fit within the standard Deliverable Obligation Characteristics. Adopting the premise put
forth in the April 18 General Interest Question would fundamentally alter the accepted Auction
price-finding model from an ISDA DC supervised transparent process with pre-defined rules
allowing the market to determine value, to a one where the DC makes initial value
determinations on an ad hoc basis, limiting the role of the market. If such a fundamental
change were advisable, which it is not, it should only be considered by ISDA through an ISDA
Board supervised process, and not by means of the answer to a general interest question.

Last week, on April 11, 2018, the ISDA Board issued a statement to reiterate the
importance for the CDS market that a DC base its determinations on objective information only:

“The credit event determination process does not allow the DC to make
subjective decisions, or to consider the intent or good faith of the parties that
put in place the arrangements leading to a potential credit event. This ensures
the process is objective and predictable, and decisions can be made quickly.”2

The determination of the Auction terms once a Credit Event determination has
been made is equally important and must apply the same rationale. Market participants desire
objective, predictable and speedy determinations with respect to Credit Events and the
settlement of CDS. A departure from the established and tested approach would be detrimental
to the functioning of the markets, chill market participants’ confidence to transact in CDS and
would be inconsistent with the stated objectives of the ISDA CDS Auction process.

Accordingly, we respectfully request that the DC reject or dismiss the General


Interest Question submitted yesterday.

* * *

We confirm that a copy of this statement may be provided for information


purposes only to the members of any Credit Derivatives Determinations Committee convened
under the DC Rules in connection with the General Interest Question to consider the issues
discussed herein, and that it may be made publicly available on the ISDA Credit Derivatives
Determinations Committee website. We accept no responsibility or legal liability in relation to
its contents.

2
See ISDA Board Statement on Narrowly Tailored Credit Events, April 11, 2018, available at:
https://www.isda.org/2018/04/11/isda-board-statement-on-narrowly-tailored-credit-events/.

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