=abbreviated CDS, it is a type of swap under which one party (Party A) agrees to pay another party (Party B) a fixed contracted amount and Party B agrees to pay Party A only upon the credit default of one or more named entities. For example, Megabank will enter into a €250m CDS with HedgeFund One to cover the default of of TechCorp. Under one leg of the CDS, if TechCorp defaults on its loans generally, HedgeFund One will pay go Megabank €250m at the time of default. Under the other leg, Megabank will pay every quarter €1m. The CDS will last for a set period of time. CDS’ are one of the legal mechanisms used to structure synthetic securitisations. If the risk covered by one leg is a pool of assets and the amount covered is not the whole face value of these assets but have an attachment point and detachment point creating tranching, the CDS becomes a securitisation. Technical Note Although nothing prevents parties from drafting a bespoke CDS, almost all CDS’ (like almost all other swaps) use the standard form generally agreed by the world’s financial market and published by the International Swap Dealers Association (ISDA). Hence the reference often seen to the ISDA standard form.
« Back to Lexicon Index