establish more objective criteria for the Restructuring event and replace the subjective "materiality" requirement with theoretically more objective criteria based on reference entity creditworthiness.
However, in the emerging markets context, in the absence of a formal regime for sovereign workouts, sovereign credit events often involve a restructuring that may not fit precisely within the 1999 Restructuring definition. For example, protection buyers sought payments under credit default swaps as a result of Argentina's restructuring of its sovereign debt in late 2001, which they viewed as voluntary in form but economically coercive. Protection sellers withheld payment, contending that the 1999 Restructuring definition required an exchange of obligations to be mandatory. Argentina later repudiated and failed to pay on its obligations, but by then some protection buyers' default swaps had terminated at maturity. Accordingly, even if default swap protection is structured to extend beyond large debt amortization dates, there is a real risk of challenge to claims of payment under credit default swaps as a result of sovereign debt restructurings.9 Participants observed that adequately defining all possible restructuring scenarios to eliminate ambiguity in application of the definition to each unique situation is extremely difficult.
In February 2003, ISDA published new Credit Derivative Definitions that attempt to tighten the credit events commonly used in the emerging market context with implementation targeted (but not binding) by May 2003. One revision requires that a "Failure to Pay” or "Restructuring" must take place within a certain time that a sovereign repudiates or declares a moratorium on obligations in order to trigger the Repudiation/Moratorium event. Another revision provides that a restructuring must be "binding" on holders of obligations to trigger the Restructuring event. 10
In tandem with challenges to the 1999 Restructuring definition in the emerging market context, different approaches to the Restructuring event evolved in the U.S. domestic and Western European markets as a result of widely publicized corporate obligation restructurings (the so- called "modified" and "modified-modified" approaches). These approaches have additional limitations, such as a cap on maturity of the deliverable obligation, in order to address concerns with the ability of the protection buyer to select the "cheapest to deliver" obligation in settlement of the credit derivative. In the emerging markets area, participants had appeared to use different versions of the Restructuring definition (full, modified, or modified-modified) depending on region. It remains unclear what impact the different approaches will have on market developments, although interview participants were generally positive regarding the refinements to the Restructuring definition in 2003. Additional clarity in the credit event definitions could alleviate concerns of protection sellers, as well as of those of dealers who seek to limit exposure to basis risk arising from differential treatment of offsetting credit derivative transactions.
In general, market participants were optimistic regarding the prospect for future EMCD market growth, and expected recent growth levels to persist over the medium term, enabling the market to roughly double again by end-2006. Participants pointed to the comparative effectiveness and versatility of credit derivatives relative to other risk management tools (e.g., NDFs, political risk insurance) and suggested that banks would likely become increasingly significant end-users for risk-management purposes. At the same time, however, participants stressed the inherent
9 Participants further noted that a "lose-lose" situation can emerge in the case of sovereign restructurings. Due to their fiduciary duties, investment managers generally hold out in a restructuring even if this proves to be suboptimal. A t t h e s a m e t i m e , i t i s u n c l e a r i f t h e y w i l l b e a b l e t o c l a i m r e d r e s s u n d e r c r e d i t d e f a u l t s w a p s f o r a r e s t r u c t u r i n g . 1 0 See Section 4.7 of the 2003 Definitions