PAUG ("Pay As You Go") refers to application of

credit derivative In finance, a credit derivative refers to any one of "various instruments and techniques designed to separate and then transfer the ''credit risk''"The Economist ''Passing on the risks'' 2 November 1996 or the risk of an event of default of a cor ...

s technology to

structured finance Structured finance is a sector of finance - specifically financial law - that manages leverage and risk. Strategies may involve legal and corporate restructuring, off balance sheet accounting, or the use of financial instruments. Securitization ...

products. It works similarly to a

credit default swap A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default (by the debtor) or other credit event. That is, the seller of the CDS insures the buyer against som ...

(CDS) with the reference entity being a structured finance product such as ABS,

commercial mortgage-backed security Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security backed by commercial and multifamily mortgages rather than residential real estate. CMBS tend to be more complex and volatile than residential mortgage-backed ...

(CMBS),

residential mortgage-backed security Bonds securitizing mortgages are usually treated as a separate class, termed residential mortgage-backed security (RMBS). In that sense, making reference to the general package of financial agreements that typically represents cash yields that are ...

(RMBS), etc. The trigger events in PAUG can be classified mainly as “credit events” and “floating rate payment events”. PAUG is a settlement methodology for CDS on ABS reference entities.

Credit Events in PAUG

*Failure to Pay Principal – The Ref Ob fails to make scheduled principal payments. *Writedown – The Ref Ob writes down (decreases) its outstanding principal amount. *Distressed Ratings Downgrade – Distressed Ratings Downgrade is an optional credit event which is triggered when the reference

obligation An obligation is a course of action that someone is required to take, whether legal or moral. Obligations are constraints; they limit freedom. People who are under obligations may choose to freely act under obligations. Obligation exists when the ...

is downgraded to 'Caa2/CCC' or below, or the

rating A rating is an evaluation or assessment of something, in terms of quality, quantity, or some combination of both. Rating or ratings may also refer to: Business and economics * Credit rating, estimating the credit worthiness of an individual, c ...

is withdrawn by one or more of the three

rating agencies A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may ra ...

Floating Rate Payment Events

Interest Shortfall – The Ref Ob pays

interest In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct ...

less than the expected interest for that period. Writedown – The Ref Ob writes down (decreases) its outstanding principal amount Principal Shortfall – The Ref Ob fails to make schedule principal payments

Settlement Mechanism

Credit Events (Failure to pay Principal, Writedown, Distressed Downgrade): A Notice of Settlement usually can be sent by the buyer only if the event is deemed to be a "credit event" by the buyer; the intent is to physically settle. The Buyer of protection has the option to physically settle or cash settle- if the Buyer chooses to physically settle, the a credit event has occurred. Floating Rate Payment Events (Failure to pay Principal, Interest Shortfall, Writedown): A Notice of settlement can be sent by the calculation agent and/or the buyer of protection for failure to pay principal and

writedown A write-off is a reduction of the recognized value of something. In accounting, this is a recognition of the reduced or zero value of an asset. In income tax statements, this is a reduction of taxable income, as a recognition of certain expenses ...

. The difference between this being a credit event and a floating rate payment event is that when an event occurs, the buyer chooses to cash settle and the trade continues (pay as you go). Interest shortfall is not considered a credit event in any instance, and is always cash settle.

References

Synthetic ABS 101: PAUG and ABX
Derivatives (finance) Credit risk