Credit Crunch New CDS Contracts

One of the impacts of the 2007—2009 financial market crisis was that CDS prices rose to hitherto unseen levels. The bankruptcy of Lehman Brothers also highlighted the issue of counterparty risk for those market participants that had bought protection using CDS. 

One response to this was that the markets changed the protocol for quoting CDS contracts. A new format for CDS in the North American market became effective from April 8, 2009. The new instruments traded with an upfront payment and fixed coupons of either 100 basis points for investment grade reference names or 500 basis points for sub-investment grade names. 

ISDA introduced a new supplement and protocol (the Big Bang protocol) and a new standard North American corporate CDS contract effective from April 2009 (SNAC). The ISDA supplement applied to new CDS transactions. It established credit determination committees, added auction settlement provisions, and created backstop dates for credit and succession events. The Big Bang protocol applies to existing CDS transactions. The ISDA SNAC, also referred to as 100/500, applies to North American names denominated in any currency. 

For high-risk reference names, CDS spreads that have widened to a large extent are quoted by market makers with points upfront. In this case, if a CDS trades with an upfront fee, a market counterparty buying protection 

The Bloomberg screen CDSW can be used to value CDS that are quoted with upfront fees, as shown at FIGURE 10.26. The trade example here is a five-year CDS quoted on May 28, 2009, on Virgin Media 

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