Template:M summ Credit Derivatives 3.13

You get to specify one Obligation Category and any number of Obligation Characteristics. Fear not, though: the Obligation Categories are rather like nested Russian dolls: each smaller one fits in the one before.

Obligation Categories

So Payment is about as wide as a payment obligation can be, and includes the Reference Entities day-to-day outgoings: rent, wages, utilities, even the paper bill, if you can find enough unpaid invoices to tot up to the Default Requirement.

Borrowed Money requires some kind of indebtedness — much discussion can be had about what is and is not indebtedness under the Cross Default page. (This is something ISDA ninjas delight in fiddler with. They really shouldn’t). But in CDS land it is actually “money you gave someone, apropos nothing beyond the clear idea they might one day give it back.

Inside Borrowed Money there are the two classic kinds of indebtedness: Loans — generally private, not easily transferable, bilateral credit arrangements (or mildly multilateral — if there is a syndicate), and Bonds — generally public, freely transferable, exchange-traded debt securities. Here you can choose one, the other, or both.

Obligation Characteristics

You can choose many of these, though some are mutually exclusive: Not Subordinated versus Subordinated being the obvious example.

The JC’s view is that if you are going to engage with credit derivatives, make them Not Subordinated. CDS is a troublesome enough asset class where it does work, superficially. It really doesn’t make sense for a capital note.

Prior Reference Obligation

There is a cheeky nod here to the Successor cluster bomb in the shape of the Prior Reference Obligation. Just what mischief ISDA’s crack drafting squad™ thought it was heading off is not clear — surely the answer is to make sure your Standard Reference Obligation table is up to date, not writing Heath Robinson machines prescribing what to do if it is not.

For really, what guide to the real world is a Reference Obligation that once existed, but now does not? Whatever may have since happened, that obligation paid itself off. What happened of successor Reference Obligations have materially different terms, tenors, and default triggers?

We may be about to find out. A DC question has been posed in exactly these terms in the fallout from the write -down of Lucky’s AT1 bonds. The Reference Obligation was indeed a Prior Reference Obligation\Aaa that had matured a couple of years ago.