6 Credit Default Swap

Credit default swap (CDS) feature is a financial derivative or contract that allows you to swap or offset your credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. Protection buyer makes periodic or one-time payments to the protection seller, who collects the premium in exchange for making payment in whole or in partial in case of default. CDS are over-the-counter (OT) transactions. These OT transactions are similar to buying or selling insurance contracts on a corporation or sovereign entity’s debt, without being regulated by insurance regulators (unlike insurance, it is not necessary to own the underlying debt to buy protection using CDS). Before trading, institutional investors and dealers enter into an International Swap and Derivative Association (ISDA) Agreement, setting up the legal framework for trading. The following functionalities are required in the system to capture the maintenance and the complete life cycle of a CDS contract:

  • Underlying details for a CDS.
  • Contract terms such as credit events maintenance.
  • Terms of exercise, standard contract features, recovery factor, premium type, and settlement details.

  • Contract capture with the respective Premium schedules as required.

  • Advice and event generation for accrual/amortization, booking, maturity, settlement, and exercise.
  • Provision for handling information on pre-settlement events such as termination or exercise.

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