Comprehensive Review of the functioning of Credit Derivatives Determinations Committees

What are determinations committees and why are they important?

Credit derivative Determination Committees (DCs) are specialised regional panels which have been established to make binding decisions on issues related to credit derivatives, particularly credit default swaps. DCs are composed of representatives from major financial institutions, including banks and investment firms, and other market participants. Key functions of the DCs include: determining whether a credit event (triggering a credit derivative) has occurred, determining whether a reference entity has a successor in the credit derivatives market, overseeing the auction process to determine the settlement price of a credit derivative and acting as a forum for resolving disputes relating to credit derivatives. DCs The International Swaps and Derivatives Association (ISDA) acts as a non-voting secretary to each DC and co-ordinates their operation.

ISDA review and consultation on possible changes to DCs

On 19 September 2024, ISDA published the results of a significant market-wide consultation carried out by The Boston Consulting Group (the DC Consultation) on proposed changes to the structure and governance of the DCs.

The DC Consultation itself originated from an independent review by Linklaters LLP (the Linklaters Report), published on 29 April 2024, which had been commissioned by ISDA to report on the function, governance and membership of DCs, and which concluded with a set of findings and recommendations (as described below) and suggested market participants be consulted as to how they should be implemented.

Linklaters review into market functioning

The Linklaters Report analysed the existing DC rules and procedures and interviewed a range of market participants, regulators and academics for their feedback on the rules and procedures. The report acknowledges the general benefits of the DC process, such as its speed, accuracy and contribution to market stability and liquidity, but also identified some areas for improvement and potential alternative models. 

The key recommendations were:

• Mitigating conflicts of interest: to mitigate potential conflicts between DCs and the matters they opine on, the report recommends that the DC rules are changed to provide for the appointment of up to three independent members (with one acting as DC chairperson), and to permit the DCs, by a simple majority, to refer questions to an independent panel for a decision.
• DC composition: noting that the current quotas are not fulfilled, the report recommends that the number of dealer members of the DCs is reduced to eight and the number of non-dealer members of the DCs is reduced to four (in addition to the CCPs and any independent members), that the eligibility threshold to serve as a non-dealer DC Member is reduced, that a non-dealer should be able to volunteer for membership of individual DCs, rather than having to join all the DCs, and that the provisions relating to consultative dealer and non-dealer members are removed.
• Governance: the report recommends that a separate governance body is established, with responsibility for overviewing the operation of the DCs (including reporting to market participants and obtaining feedback from them) and making changes to the DC rules from time to time (rather than the DCs themselves).
• Representation and transparency: the report recommends that the DC rules are changed so that eligible market participants (i.e. parties entitled to convene a DC) are entitled to present statements of case within certain parameters, that any material step taken in the DC process (including any request to convene a DC, any statement of case submitted and any public information provided or obtained by the DC in connection with a DC question) must be disclosed on the DC website as soon as is reasonably practical, and that the DCs and the DC secretary are required to provide adequate reasons (stated on the DC website) for all material decisions they take.
• Funding: the report recommends that views are sought about the appropriate funding model for the DCs (in particular, whether a transaction-based levy of some sort would be acceptable), and that a working group is established to prepare detailed proposals.

ISDA consultation on changes to DCs

The DC Consultation gathered feedback from 50 market participants, including sell-side, buy-side, and infrastructure providers, across three regions (Americas, EMEA, and APAC), on five major themes: governance, DC composition, representation and transparency, conflicts of interest and funding.

The measures that were consulted on include:

• establishing a separate governance body for overseeing the operation of the DCs and making changes to the DC rules from time to time.
• allowing the governance body to appoint independent auditors to audit DC members’ compliance with the DC rules.
• reducing the target number of dealer members to eight and the number of non-dealer members to four (in addition to central counterparties and any independent members).
• reducing the eligibility threshold to serve as a non-dealer DC member from the current $1 billion in CDS notional outstanding referencing a single reference entity.
• allowing non-dealers to volunteer for membership of individual DCs, rather than having to join all the DCs.
• streamlining the DC rules by removing provisions relating to consultative dealer and non-dealer members.
• allowing eligible market participants to present statements of case within certain parameters.
• requiring the DCs and the DC secretary to provide and publish adequate reasons for all material decisions they take.
• disclosing any material step taken in the DC process on the DC website as soon as is reasonably practical.
• appointing up to three independent members of the DCs (with one acting as DC chairperson).
• enhancing minimum requirements on DC members’ compliance procedures.
• enabling the DCs, by a simple majority, to refer DC questions to an independent panel for a decision.
• developing a new model to adequately fund the operations of the DCs.

There was broad support for many proposed changes, such as establishing a separate governance body, reducing the target number of dealer and non-dealer members, providing reasons and material steps for decisions, however some changes require further detail and refinement, such as appointing independent auditors, setting new thresholds for non-dealer sophistication, disclosing information with statements of case and implementing a transaction-based levy. In general, the survey results indicate a strong desire among market participants for reforms that will enhance the independence, transparency and efficiency of the DCs.

The report suggests that a phased approach would be preferable for implementing the proposed changes, prioritising the ones that have broad consensus and developing the others with more industry input and guidance from the new governance body.

Conclusion

The DCs have sometimes been perceived as opaque, but they are a crucial corner of the derivatives market. In general, the DCs are seen as operating effectively at the moment, but, as is regularly seen, market confidence in important institutions can erode quickly. ISDA can therefore be applauded for pro-actively seeking to improve the DC rules to strengthen the foundations of the DC rules. The fact that almost all proposed changes in the DC Consultation received broad market support shows that they are sensible and should be quickly and relatively painlessly assimilated into updated