By Karen Brettell

NEW YORK, July 28 (Reuters) -Credit derivative dealers are
considering changes in the way some credit default swaps are
traded to require larger upfront payments, as concerns about
corporate credit risk rises.

Dealers are in talks about changing contracts that insure
the debt of individual companies so that they are more similar
to corporate bonds or credit derivative indexes, by requiring
larger upfront payments and a set coupon, instead of only
making payments on a quarterly basis, analysts said.

This would reduce the risk of protection sellers not
receiving payments from the contracts as the risk of companies
defaulting on their debt rises, and would make it easier for
dealers to manage a myriad of positions they have on corporate
debt.

The move may also impact the liquidity of the market,
helping high yield trading though potentially scaring away some
investment grade protection buyers.

"There are several problems to trading everything on an
on-market spread basis," said Brian Yelvington, analyst at
credit research company CreditSights.

At present, buyers of protection against a single company
defaulting on its debt pay a quarterly coupon for the life of
the contract, which is most commonly for five years. This
coupon is set by the spread the swap is trading at when the
contract is entered into, and is referred to as the on-market
spread.

For example, to protect against a default by New York Times
Co, one of the widest trading names in the U.S. investment
grade index, a buyer would pay an annual rate of 3.95 percent
of the sum insured, based on Monday's prices, or 0.98 percent
per quarter.

Contracts on individual companies only require upfront
payments when their spreads near the 10 percent mark, a level
generally considered as distressed.

As the economy weakens and credit spreads widen, however,
protection sellers want to be paid more for the default risk at
the outset of a greater number of contracts.

"This wasn't a problem when spreads were benign but now
that spreads are wider, this indicates a higher degree of risk
in the market, meaning those future cash flows are more in
doubt," Yelvington said.

"Moving to a standard coupon would make pricing a lot more
transparent and should improve the speed of trading," he
added.

Also, "when you have to exchange cash, mistakes are found
earlier since if the mistakes were material to the calculation,
they will impact it and the money delivered will not be correct
per one counterparty or the other," Yelvington said.

IMPLEMENTATION CHALLENGES

In spite of these benefits, the challenges over changing
the terms of the contracts could be significant.

"I think it is a step forward in simplifying the entry and
exit of positions but brings up as many problems as it solves,"
said Tim Backshall, chief derivatives strategist at Credit
Derivatives Research in Walnut Creek, California.

Some dealers have floated the idea that the coupon for
investment grade credits be based on the spread of benchmark
credit derivative index, with prices then adjusted for a
company being weaker or stronger than the index.

However, as a new series of the index is introduced every
six months, credit default swaps on a single company could have
various coupons, and some may risk being less liquid than
others.

Also, spreads on individual companies can be wider, and
more volatile than on the indexes.

"The big difference is that the single-names can be
considerably more volatile than the indexes and so upfronts can
become very large and potentially negate any liquidity
improvements," Backshall said.

Large upfront payments may make some protection buyers more
hesitant to put on a trade than if they were only required to
make quarterly coupon payments.

"High yield investors are more likely to favor coupon
payments because the spreads of high yield companies are so
wide, though some investment grade investors may be worried
about losing liquidity depending on standard coupon
assumptions," CreditSights' Yelvington said.
(Editing by Leslie Adler)