A LCDS is a credit default swap where the Reference Obligation and only Deliverable Obligation is a specific loan rather than any other assets (e.g bonds (corporate or sovereign), other loans, asset-backed, securities, etc.).
LCDS is a contractual arrangement between two parties (the Protection Buyer and the Protection Seller) in which the Protection Seller indemnifies the Protection Buyer from described “Credit Event Risks” associated with the underlying Deliverable Obligation (the underlying “risk obligor”). In exchange for the indemnification, the Protection Buyer transfers the specific underlying Deliverable Obligation (the loan) to the Protection Seller. LCDS has been employed as a risk mitigant by a wide range of financial institutions for a number of years as such there is well established market practice and legal framework centred upon Master ISDA documentation.
- LCDS Protection Buyer – this is typically financial institutions seeking to reduce its overall exposure to a certain asset, similar taking out credit insurance to reduce aggregate exposure.
- LCDS Protection Seller – Typically funds on investment grade rated banks, that provide risk mitigation to the LCDS protection buyer, by selling an LCDS protection on specific loans.
- Reference Entity – This is the borrower in the underlying Deliverable Obligation,
LFC acts as LCDS protection seller, allowing its counterparties (LCDS Protection Buyers) to hedge the credit event risks associated to a specific syndicated or bilateral loans.