The following Banking & Finance guidance note provides comprehensive and up to date legal information covering:
A credit derivative is a bilateral transaction which takes its underlying value from the credit risk of a third party, known as the 'reference entity'—a corporate, sovereign, municipality or other similar organisation. The reference entity issues reference obligations, which refer to its specific underlying obligations (eg bonds or loans).
The primary purpose of a credit derivative is for a party (known as the ‘protection buyer’) to buy credit protection to mitigate against the risk of a defaulting reference entity. The party assuming the credit risk of the reference entity is known as the 'protection seller'. If a credit event occurs on the underlying reference obligation, the payment obligations under the transaction will be triggered and the transaction settled.
For general information on credit derivatives, see Practice Note: What are credit derivatives?
A credit event occurs when the reference entity defaults. Credit events for each transaction are chosen by the parties and specified in the relevant confirmation. They are based upon the credit events set out in section 4 of the 2014 ISDA Credit Derivatives Definitions (the 2014 Definitions) (as amended by the 2019 Narrowly Tailored Credit Events Supplement to the 2014 Definitions). These are:
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