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Swaps market trade association ISDA set a precedent last week by calling a restructuring credit event on Thomson SA that will test the organization’s new bucket auction for the first time. The decision prompted grumbling among CDS dealers, some of whom told Debtwire they may boycott the auction as they push for a failure-to-pay trigger.
But the would-be holdouts will not find the public proof they need to trigger a failure-to-pay event on the French multi-media group, said a source close to the company. “Dealers and hedge counterparties [who are] trying to determine whether there is a failure to pay are getting themselves into a twist,” said the source.
In the highly legalistic world of CDS, ISDA requires two public sources of information to call a credit event – commonly restructuring, bankruptcy or failure to pay – that would trigger the swaps.
Unlike the failure to pay and bankruptcy credit events, a restructuring credit event is discretionary, meaning dealers can choose whether they want to participate in an auction or not. A restructuring event also triggers a bucket auction that several dealers say they oppose because of the disparate recoveries that will result on swaps of different maturities.
“Our legal is recommending [we] wait before triggering on restructuring,” said a senior trader at one CDS dealer. The heads of two sellside trading desks said earlier last week that they are still angling for the declaration of a failure to pay.
Holdouts or leftouts?
That gamble could backfire if proof of a payment default doesn’t make its way into the public purview. Thomson’s restructuring makes such a disclosure as unlikely as possible.
The multimedia group tripped a restructuring credit event on 15 June by waiving a payment due to holders of EUR 1.1bn private placement notes with whom it had been negotiating for months. Management announced the waiver in a statement released last week, catalyzing ISDA’s decision to hold a bucket auction.
Thomson contends that the investors gave up their rights to a payment previously owed, agreeing instead to the restructuring plan and therefore rescheduling the payment, said the source close to the company.
If a payment default on the private placement were publicly disclosed, holders of the company’s EUR 1.7bn secured loans and other debt could demand immediate payment in full.
“The payment was waived and extended [and noteholders’] right to the payment was given up,” he continued, adding that from the company’s perspective there is little difference between the economics of the two auction processes.
Small Bang, big opposition
Actual counterparties to the swap contracts take a decidedly different point of view. “People are [angry],” said one US-based trader. “This [bucket auction] is far more complicated than it needs be. So much for the Small Bang standardizing things,” he said.
ISDA designed the bucket approach to settlement – a series of mini auctions broken down by maturity of CDS contract – as part of its Small Bang protocol to stop CDS holders from engaging in deliverables arbitrage. The new structure would prevent counterparties from delivering long-dated bonds that may be trading at a discount to shorter-dated paper regardless of the maturity of their CDS contract.
In a restructuring auction, a buyer of protection can deliver a bond subject to a maximum maturity of five years for restructured debt, and two-and-a-half years for non-restructured debt, as reported. Settlement will be staggered in multiple auctions, or buckets, carrying 2.5-, five-, 7.5-, 10-, 12.5-, 15, 20 and 30-year maturities.
ISDA’s vote to call a bucket auction was split, with 13 dealers in favor of calling a restructuring credit event and two – Bank of America/Merrill Lynch and Legal & General – voting against.
Some Thomson CDS holders, particularly those with shorter-dated contracts, fear that recoveries will vary widely depending on which auction bucket they participate in, said the second dealer source. It is expected that the 2.5-5 year bucket, capturing contracts up to 20 June 2014 will be the most active auction, given that the loan due in 2012 falls within its range, said the second trader.
ISDA’s Determinations Committee was given a trigger and has gone ahead with a restructuring event, he continued, adding that it would be a surprise if dealers were to wait for a future failure-to-pay event.
Deutsche’s call
If Thomson implements its restructuring in 4Q09 as planned, it will push its maturity schedule mainly to 2016 when EUR 1.06bn is due. But the auction will take place with buckets and deliverables built around the company’s old capital structure, with the loan set to mature 2012.
Only a minority of the creditors signed up to Thomson’s restructuring agreement hold CDS, with around 20%-30% of its EUR 1.7bn RCF hedged and most private-placement noteholders unhedged, said the source close to the company. Deutsche Bank holds EUR 400m of Thomson private-placement notes and Thomson has previously stated that the German bank has not agreed to its restructuring proposal.
The two parties are still negotiating, said the source close to the company. Thomson is expecting some degree of ownership change due to a certain amount of physical deliverability, but this should not affect existing majorities, added the source.
Under ISDA protocol, the CDS buyer has the right to take the price from earlier maturing paper by exercising a movement option built into the auction. If an auction is not held for a particular maturity bucket, counterparties with CDS matching that maturity have the option to settle their swaps using the price determined for an alternative bucket.
Buyers of protection may exercise this option if there is an auction with fewer deliverable obligations than those available to settle the particular transaction. In that case, the final price from any auction with the largest number of deliverables will apply, explained a trader.
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