Sellers of insurance against Thomson defaulting on its debts are unlikely to have to pay out – even though the French media group’s restructuring of a specific note has been deemed an official credit event.
Market observers said yesterday they expected many buyers of Thomson-linked credit default swaps to sit tight during the forthcoming auction process and not demand a payout.
After a credit event has been declared, an auction takes place to determine how much sellers of the insurance have to pay out.
The Thomson “event” was triggered after the company agreed to defer payments on some privately held notes.
Because it has been classified as a “restructuring” rather than the more serious “failure to pay”, investors can choose to hold their contracts and to ignore the auction.
Failure to pay would have forced all parties to participate. Analysts say some investors may hold back and bet on this more serious ruling. What makes the case more difficult is the fact that the notes were a private placement. The extent of any documentation is unknown.
The Thomson auction process will be closely watched because it is the first testing of the so-called “small bang” protocol introduced in July by the International Swaps and Derivatives Association. The rules are still bedding down.
Juliano Torii, TMT credit analyst at Société Générale, said take-up for the restructuring event auctions would depend on maturity dates of outstanding CDSs.
“A lot of early maturity investors – anything up to two and a half years – will be reluctant to trigger as the recovery rate will be too high, but instead will hold out for a failure-to-pay decision where all maturities would be treated the same,” said Mr Torii.
It is also the first event to involve a current index. Many CDS investors deal in contracts that reference a wider index rather than an individual name. Thomson is included in the widely followed current iTraxx Crossover index of 45 names. Payouts on index contracts will reflect only the portion of the contract relating to Thomson, not the broader index.
“We think the broader market impact of this credit event will be limited,” said Peter Goves, a strategist at Citigroup. “[But] there is potential for the new protocol to come under pressure in an auction that leaves those with outright short positions out of pocket.”
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