Investors synthetically referencing the recently bankrupt U.S. auto parts manufacturer Dura Automotive Systems, for the first time this week, will use the International Swaps and Derivatives Association's (ISDA) revamped auction protocol. Tuesday will bring the first auction protocol that opens up the cash settlement option to a much wider range of derivative instruments - including single-name CDS, first-to-default baskets and constant maturity swaps - along with the traded indices. Cash settlement will take place on Dec.12.
The protocol allows protection buyers and sellers the option to change the terms of their contracts from physical to cash settlement. The switch toward cash settlement is becoming increasing necessary, as more and more investors have piled into the credit derivatives market. In many cases, their trades far outpace the supply of physical bonds they reference, making for a sticky, technical-driven, situation when a credit event comes around.