Last week saw an important milestone in the credit default swaps sector, when counterparties to CDS trades on Lehman Brothers cash-settled their transactions.
Based on a protocol and auction process developed by ISDA, protection sellers paid 91 cents on the dollar to protection buyers. An estimated $6bn to $8bn was paid out. Over the past 25 years, the privately negotiated derivatives industry has developed a robust framework – one that governs and guides participants through such an event, and which includes procedures and processes for valuing and unwinding trades. Recent defaults show the value of these efforts – the industry’s infrastructure clearly works.