Lesson 05 · 5 min

Credit: Trading Protection

A CDS is two legs: a periodic premium and a contingent protection payout gated by credit events.

The deal on the desk

Pershing Square holds bonds issued by ABC Industrial Corp and is starting to worry about the issuer. Selling the bonds would crystallize a loss, so Pershing Square buys protection instead: Goldman Sachs agrees that if ABC suffers a credit event, Goldman makes Pershing Square whole on USD 10,000,000 of exposure. In exchange, Pershing Square pays 1% per year, quarterly, for five years. That is a credit default swap, and you already know both of its legs.

The protection leg, on the wire

{  "payerReceiver": {    "payer": "Party1",    "receiver": "Party2"  },  "generalTerms": {    "referenceInformation": {      "referenceEntity": {        "name": "ABC Industrial Corp",the name you are long or short        "entityIdentifier": [          {            "identifier": "549300Q7GH25ZTM4B803"          }        ]      },      "referenceObligation": [a specific ABC bond        {          "security": {            "identifier": [              {                "identifier": "US24690DAA04",                "identifierType": "ISIN"              }            ]          }        }      ]    }  },  "protectionTerms": [    {      "creditEvents": {        "bankruptcy": true,        "failureToPay": {missed payments above 1m count          "applicable": true,          "paymentRequirement": {            "amount": {              "value": 1000000,              "unit": {                "currency": "USD"              }            }          }        },        "restructuring": {          "applicable": true,          "restructuringType": "ModR"which restructuring flavor applies        }      }    }  ],  "priceQuantity": {    "resolvedQuantity": {      "value": 10000000,      "unit": {        "currency": "USD"      }    }  }}

What counts as a credit event

CreditEvents↗ is the contract's definition of trouble. Every trigger is a field the parties switch on or off, and the protection leg stays dormant unless a switched-on event actually occurs. The menu groups naturally:

• Missed payments and defaults. failureToPay carries the paymentRequirement threshold you saw in the JSON, so immaterial misses cannot trigger protection, plus an optional grace period extension. obligationDefault and obligationAcceleration cover covenant breaches that make debt repayable early.
• Bankruptcy. The bluntest trigger: insolvency proceedings against the reference entity. A single boolean.
• Restructuring. Adverse changes to the debt's terms rather than outright default. Because jurisdictions disagree on how much should count, restructuringType names the market convention: ModR (modified), ModModR (modified modified), or R (full restructuring).
• Sovereign and financial-sector events. repudiationMoratorium for sovereigns that disclaim their debt; governmentalIntervention and writedown for banks whose bonds are bailed in rather than defaulted on; maturityExtension and distressedRatingsDowngrade for specific market segments.

Two more fields make the machinery precise. defaultRequirement sets a minimum aggregate amount for default-style events, the same idea as the failure-to-pay threshold. And creditEventNotice spells out how an event is formally asserted: which party may deliver the notice (one side or either), and whether publicly available information must back the claim. In practice, determinations committees rule on whether an event occurred; the data records which events these two parties signed up to, and at what thresholds.

Single name, derived name

Qualify_CreditDefaultSwap_SingleName↗ checks the now-familiar pattern: a credit default payout whose generalTerms carry referenceInformation for one entity. If indexReferenceInformation had been populated instead, naming a credit index rather than one company, the index CDS qualifier would claim it. Same legs, different branch, different name.