From Russia with love; CDS definition born in 1998 crisis triggers Bradford & Bingley auction

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Ten years ago, in the wake of Russia’s bank debt holiday, David Benton helped draft credit derivatives documentation stipulating that such interventions would not prevent the trigger of credit default swap payments, Debtwire reports. Fast forward to the present and the partner at Allen & Overy is trotting that obscure clause out to deal with the decrees of a far less likely culprit, the British government.

The UK Treasury dictated in February of this year that Bradford & Bingley could defer interest payments on its bonds, a policy the nationalized mortgage lender took advantage of last month. The missed coupon may have been government sanctioned, but it still constituted a failure to pay event under the clause (4.1) that Benton helped design for the International Swaps and Derivatives Association’s (ISDA) definitions in 1999.

After much debate, ISDA released yesterday a list of deliverable securities for Bradford & Bingley’s CDS auction that includes the subordinated debt affected by the Treasury orders. Approximately USD 413m of contracts were written on the name, according to the Depository Trust & Clearing Corporation figures, and a CDS auction is expected to be held 30 July.

A spokesperson for Treasury did not return request for comment. ISDA was not immediately available for comment.

Back to the future, Moscow style

The Russian government announced a 90-day moratorium on the payment of certain bank obligations in August 1998 as the market for the sovereign’s own debt collapsed. “There was a crisis of confidence in the government’s ability to sustain the payments,” said Luis Costa, an emerging markets strategist at Commerzbank who traded Russian bonds at Delta Asset Management when the Russian crisis blew.

At the time, credit default swap referencing Russian securities barely existed, Costa said. Even so, the threat of future interventions prompted Benton, along with a transatlantic team of lawyers, to draft clause 4.1.

The definition states that a credit event can be triggered by a missed payment regardless of whether the default “is subject to a defense based upon… any applicable law, order, regulation, decree or notice, however described.” In simple terms, that means a failure to pay credit event can be called if one would have occurred had it not been for an act of government.

UK Treasury executed the orders concerning Bradford & Bingley to effectively prevent funds leaking out to subordinated debtors, commented one bondholder. “It was the first thing they [the government] did [post-nationalistion], overriding contractual agreements on the bonds [and] effectively changing the instruments into perpetuals.”

The coupon deferral prompted dealers to seek a credit event trigger, and they debated failure to pay, restructuring and bankruptcy as possible trips. Advice was sought from Benton and fellow partner Simon Haddock. They hung a failure to pay trigger from clause 4.1, marking the first such decision since the creation of the definition.

Today Bradford & Bingley’s short dated senior debt is quoted around 85-bid, while subordinated debt is indicated around 8-mid, traders said. CDS on the name no longer trades, although Markit is quoting the cost of five-year protection on the name at 1095bps-mid.

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