In a world of central clearing, we also need standardized contracts.

Clearing houses will not accept an infinite spectrum of CDS premiums and maturity dates.

They want certain standardized contracts which everyone trades.

This allows for easier clearing and netting of trades, as well as trade compression and neat unwinding of existing positions.

The standardization has two main effects on the product mechanics.

Firstly, standardized maturities are traded with the five year being the most liquid.

Secondly, standardized coupons are agreed with 100 and 500 basis points being the most common credit event language is also agreed and fixed recovery assumptions.

Usually 40% for senior debt and 20% for junior debt are used for pricing and margining purposes.

Different standard contracts exist, examples of which are the SNAC, the standard North American contract, STEC, the standard European contract, and STAC, the standard Australian contract.

Each contract will have slightly different conventions for coupons and credit event language.

It's worth just expanding slightly on what we mean by standard maturities.

This does not, as the name might suggest, mean that the market trades exact two year or five year swaps every day because each of those swaps would have a new maturity date each day and would therefore not match previously traded swaps.

Instead, the standardized maturities refer to standard fixed maturity dates.

This way cdss with the same final maturity date can be traded each day and long and short positions netted by the clearinghouse.

A standard five-year contract may be launched with a mid-December maturity date and quarterly coupon payments of 100 or 500 basis points per year.

This contract will trade as the on the run five year for six months until a new five year contract is launched with a mid-June maturity.

This semi-annual renewal means that there is always a standard contract that the market will trade as the five year the old contracts continue and are now called off the run.

Traders may choose to roll out of off the run positions into the new on the run contract.