The aftermath of the 2014 ISDA Credit Derivatives Definitions - speed read
A review of important developments in the credit derivatives market since the 2014 ISDA Credit Derivatives Definitions were implemented in October 2014.
Simmons & Simmons has published a briefing on “The Aftermath of the 2014 ISDA Credit Derivatives Definitions” describing developments since the 2014 Definitions were implemented in October 2014. There have been a number of interesting events since then, many of which are heavily fact-specific, and described in detail in the briefing to help identify issues and provide a guide as to how complex situations may unfold in future.
Set out below are the 12 key points to take away from the briefing:
- Debt Restructurings: The presence of CDSs continues to have a significant impact on the way corporate debt restructurings are handled. The issues are heavily fact-specific. See for example briefing sections 3.1 (Caesars Entertainment Operating Company (CEOC)), 3.2 (RadioShack), 4.2 (PTIF) and 7.2 (Norske Skog).
- Bankruptcy: Moving the word “similar” in s.4.2(f) of the 2014 Definitions has had a significant impact in narrowing the scope of insolvency/restructuring filings that trigger a Bankruptcy Credit Event. Much depends on the insolvency laws where the filings are made, which will not always be the country where the Reference Entity is incorporated. See briefing section 4 (Non-US Bankruptcy Credit Events).
- Governmental Intervention: The new Governmental Intervention Credit Event does not capture all government actions that cause losses for bondholders/lenders, particularly where bridge institutions are involved (or circumstances with similar effect) and the affected debt continues to exist albeit backed by a less creditworthy entity. See briefing section 6 (Governmental Intervention Credit Events).
- Repudiation/Moratorium: The first Repudiation/Moratorium Credit Event that a DC has determined occurred for Ukraine. The DC determined that a Potential Repudiation/Moratorium occurred when the relevant law was passed, not when a prior announcement was made. The relatively slow process leading up to an actual Repudiation/Moratorium was highlighted when the DC made a number of determinations conditional on the relevant events occurring, including an extreme Auction acceleration. See briefing note 5 (Repudiation/Moratorium Credit Events).
- Restructuring: The events around the Norske Skog exchange offer and consent solicitation highlighted a number of difficulties with Restructuring Credit Events, including difficulties establishing acceptable exchange offers in the first place and CDS hedging mismatches. See briefing section 7.2 (Norske Skog).
- Qualifying Guarantees: The wider definition of Qualifying Guarantees in the 2014 Definitions has led to bonds being deliverable under that that were not deliverable under the Updated 2003 Definitions. This was because the 2014 Definitions permit guarantees that can be released in certain circumstances, which in this case was a release when a single transferee assumes responsibility for it. See briefing section 7.2 (Norske Skog).
- US Municipals: The first Credit Event on a US Municipal Reference Entity occurred with the Failure to Pay triggered by Puerto Rico. There were no particular difficulties in triggering and settling affected CDSs. See briefing section 8 (US Municipal Reference Entities).
- Auctions: DCs have continued to manage the Auction process to improve their chances of producing fair and meaningful outcomes and to ensure that they tie in with timings for debt restructurings (e.g. so that Auctions are settled in time for the buyers in the Auction to receive the debt and exercise voting rights in the debt restructuring). A single Auction has regularly been held to settle CDSs under both the Updated 2003 Definitions and the 2014 Definitions, but only where their Deliverable Obligations are identical. For example, see briefing sections 3.3 (Alpha Appalachia), 4.2 (PTIF), 4.3 (Isolux Corsán Finance (IC Finance)), 5 (Repudiation/Moratorium Credit Events) and 7.2 (Norske Skog).
- Successors: A number of events have led to the definition of Relevant Obligations being considered in detail, leading to different outcomes under the Updated 2003 Definitions and the 2014 Definitions in some cases. See briefing section 10 (Successor Determinations), particularly sections 10.4 (Windstream Services) and 10.6 (Novo Banco).
- EU Antitrust Investigations: Markit and ISDA have offered commitments to licence the use of iTraxx/CDX and Auction Final Prices to exchanges on fair, reasonable and non-discriminatory terms, and to exclude the dealer banks from making or influencing licensing decisions. The European Commission has adopted a Commitments Decision to make those commitments legally binding. See briefing section 11 (European Commission Antitrust Investigation).
- Determinations Committees: DCs are generally publishing thorough explanations for their decisions. The DC Rules have been amended to strengthen safeguards against possible conflicts of interests and ensure that traders, structurers and other business people in areas affected by CDSs cannot sit on the DC. Overall, these changes will improve transparency of the DC decision-making process and increase confidence in the DC Resolutions, thereby improving confidence in the CDS market as a whole. See briefing section 12 (DC Determinations and Rules).
- Standard Reference Obligations/Package Observable Bonds: The identification of SROs has been slower than expected, with all the ones identified so far being for Financial Transaction Types (mostly European Financial Corporate). The identification of POBs has been almost non-existent, with just the three identified for Greece so far. See briefing section 13 (Standard Reference Obligations and Package Observable Bonds).
The briefing concludes by finding that many of the developments have been hugely welcome, but noting that there are still issues to watch out for when, based on the facts, CDSs might not lead to expected outcomes thereby resulting in hedging mismatches.
