Annual Spring Conference May 14-15, 2014 Amsterdam

Transcription

1 Annual Spring Conference May 14-15, 2014 Amsterdam IACPM Credit Supernova Why and how the 2014 ISDA Credit Derivatives Definitions are changing Abel Elizalde Citi Research Director Simon McKnight Linklaters LLP Counsel

2 Overview This presentation will give a high-level introduction to: Issues with existing 2003 ISDA Credit Derivatives Definitions + July 2009 Supplement in specific scenarios: What went wrong? What could have gone wrong? What s new in 2014 ISDA Credit Derivatives Definitions Things to watch out for 2

3 ISDA Credit Derivatives Definitions + May 2003 Supplement itraxx/cdx indices formed Physical settlement squeezes ISDA Credit Derivatives Definitions 2004 Auctions and Auction Protocols developed Odd results Eurozone crisis Basel III Solvency II Main events so far Exponential growth July 2009 Small Bang Protocol and July 2009 Supplement Matrix Supplement + Matrices Determinations Committees Auctions hardwired Fungibility April 2009 Big Bang Protocol and March 2009 Supplement Financial crisis Calls for clearing 3

4 What went wrong? What could have gone wrong? Financials Sovereigns Others 4

5 SNS Bank (2013) Dutch bank, subsidiary of SNS Reaal Small name in CDS market, both senior and subordinated CDS Dutch government expropriated subordinated debt, so not deliverable into CDS/Auction Purposive interpretation of Mod Mod R Credit Event Auction final prices same for senior and sub. CDS: 95.5% for bucket 1; 85.5% for bucket 6 sub. CDS payout just 4.5% or 14.5% Political pressure for bail-ins make this sort of occurrence more likely in future particularly in EU following Bank Resolution and Recovery Directive 5

6 Anglo Irish (2010/11) Two-stage restructuring Three series of subordinated bonds outstanding, maturing 2014, 2016 and 2017 Exchange offer and exit consent on 2017 bonds to trigger Mod Mod R 2014 and 2016 bonds deliverable into subordinated CDS auctions (5- yr/7.5-yr buckets had auction final prices of 76%/74.5% for senior and 18.25%/18% for sub) Subsequent exchange offer and exit consent on 2014 and 2016 bonds Irish Life and Permanent restructuring effected in similar manner Would not have worked with only one series of sub bonds remaining Restructuring in anticipation of bail-in Outcome should be same as for government intervention 6

7 Bankia ( ) CDSs Caja Madrid Bancaja Dec 2011 Caja Madrid sub. debt matured 10 April 2012 orphaned CDS Credit event April 2013 Caja de Canarias Caja de Ávila Senior debt Sub. debt Banco Financiero y Ahorro (BFA) Jan 2012? Senior debt Bankia Caixa Laietana Caja Segovia Caja Rioja CDSs (senior and sub) CDSs (senior and sub) 7

8 Deliverable obligations 315 new domestic Bond notional x auction final price Greece (2012) Controversy Concerns that a voluntary haircut not a credit event Less confidence in sovereign CDSs but fortunately Exercise of CACs in domestic bonds triggered Mod Mod R Albeit domestic bonds exchanged before could be delivered Auction accelerated Example for bondholder hedged under a CDS CDS seller Premium CDS notional x (1 auction final price) 785 Auction final price = 21.5% Say CDS notional 1,000 1,000 domestic bond 315 new domestic bonds GDP-linked bonds EFSF bonds Auction Bondholder Bond 8

9 Threat of Eurozone break-up (2012) Restructuring credit event can occur if debt redenominated into non-permitted currency (subject to other conditions as well) Permitted currencies include domestic currencies of G7 countries or OECD members that are AAA rated Some countries leaving Eurozone could trigger Restructuring (e.g. Spain), others would not (e.g. Italy) Deliverable obligations satisfying standard specified currencies? 9

10 Others Issues in practice Unitymedia missed succession event RBS difficulties in determining successor because of disposals in several steps Generali write-down provisions in subordinated obligations failed not contingent deliverable obligation characteristic Things that could have gone wrong Legally binding bond exchanges where not a credit event Solvency II debt not deliverable, so running out of deliverables for CDSs on European insurers Guarantees succession 2003 Definitions prevent succession where debt still guaranteed by original reference entity (does not have to be qualifying ), but had to be qualifying to be deliverable 10

11 What s new in the 2014 Definitions? 11

12 Key provisions changed Financial reference entity terms/ governmental intervention Sovereign Restructurings Currency redenomination Solvency II Standard reference obligation Successors Qualifying guarantee Restructuring credit events Outstanding principal balance Asset package delivery See New 2014 CDS Definitions: What s new? What s changing? Why? When? How?, A. Elizalde, 26-Feb. 12

13 Asset Package Delivery Financial Reference Entity Governmental Intervention Restructuring of Reference Obligation Prior Deliverable Obligation Reference Obligation Asset Package Sovereign Restructuring Package Observable Bond 13

14 Examples: Financials & GI credit event SNS Bank Final price for subordinated debt would have been 0% Sub. CDS holder would have received 100%, not 4.5% or 14.5% What if sub. bondholders had received equity and/or cash? CDS Auction CDS seller Premium NA x (1 AFP) CDS buyer Asset package NA x AFP RAST counterparty Bond Asset package (e.g. equities, commodities) 14

15 Effect on Greece and Eurozone generally? Greece Bond exchange would have triggered Restructuring credit event Asset package delivery would have applied Eurozone Italy/Spain leaving for own currency would not trigger if no haircut (+ others) May affect CDS on corporates in those countries: will corporate debt be redenominated into new currency? may not be deliverable Example for bondholder hedged under a CDS CDS seller Premium Asset package 1,000 Say CDS notional 1,000 1,000 domestic bond 315 new domestic bonds GDP-linked bonds EFSF bonds Bondholder Bond 15

16 Currency redenomination Restructuring Credit Event Fixed list of 6 permitted currencies Redenomination out of euro not a Restructuring if: results from action of a governmental authority of an EU Member State of general application in its jurisdiction there was a freely available market rate of conversion no write-down of interest, principal or premium at such market rate and no need for deterioration in creditworthiness for leaving euro Deliverability Standard specified currencies include (a) successor currency to euro in France and Germany and (b) successor currency to euro as a whole 16

17 Solvency II Subordinated European Insurers Solvency capital provisions anticipate a release from payment to meet Solvency II requirements Does not satisfy not contingent deliverable obligation characteristic Carve-outs in various places to permit this permitted contingency qualifying guarantee maximum maturity deliverable obligation characteristic 17

18 Standard Reference Obligation Standard Reference Obligation SRO list to be published by ISDA Senior level and subordinated level to be specified in confirmation Rules for selecting and substituting outside 2014 Definitions Transition provisions in draft SRO rules Non-Standard Reference Obligation Can specify in confirmation Provisions for selecting and substituting in 2014 Definitions 18

19 Successors Corporates No succession event now, have steps plan Universal successor Sovereigns Relevant obligation threshold percentages now apply Sovereign succession event Financials Senior/subordinated CDS split 19

20 Qualifying Guarantee Amendments to the definition of qualifying guarantee A guarantee with the following provisions may now qualify as a qualifying guarantee: a fixed cap a provision providing for a permitted transfer of the guarantee provisions providing for a release as a result of a governmental intervention (for financial reference entities) solvency capital provisions which anticipate a release from payment to meet Solvency II requirements and/or a release provision which has been switched-off by the occurrence of a bankruptcy or failure to pay by the underlying obligor Statutory guarantees are expressly stated to be agreements in writing 20

21 Restructuring Credit Events Generally A bond exchange can constitute a Restructuring (compare old and new terms) Currency redenominations addressed Old R No longer optional (i.e. no credit event notice needed) Mod R and Mod Mod R Enabling obligation concept removed Mod Mod R only Limited to 4 maturity buckets: 2.5, 5, 7.5 and 10- year limitation dates Restructured bond or loan deliverable into bucket into which it fell before the Restructuring 21

22 Outstanding Principal Balance New definition of outstanding principal balance Three-step process which asks: what is the principal due? what amount of that is non-contingent? if such non-contingent amount was payable today, what is the quantum of the claim in respect thereof? Permitted contingencies include solvency capital provisions and provisions anticipating a governmental intervention The not contingent deliverable obligation characteristic has been removed from the 2014 Definitions 22

23 What you should watch out for 23

24 Next steps Implementation due around 20 September 2014 roll date Impact global, albeit greatest in Europe ISDA protocol anticipated to amend certain existing CDS will not cover financials and sovereigns specified list of affected corporates details not yet finalised consider hedging mismatches, particularly with credit linked notes Roll market anticipated for non-protocoled CDSs Further ISDA documents to come SRO rules/list, POB rules/list, DC rules CoCo Supplement for Swiss banks Should you sign the ISDA protocol? For nonprotocoled CDSs, should you roll from 2003 to 2014? When? 24

25 Questions? 25

26 Speaker biographies Abel Elizalde Abel Elizalde covers European Credit Derivatives Strategy at Citi, currently based in London. Abel started with Citi in December 2012 and previously worked at J.P. Morgan, Bear Stearns and Merrill Lynch in Credit Derivatives Strategy. Simon McKnight Simon specialises in derivatives and structured products transactions, both in securitised and OTC forms. He has particular experience in credit derivatives, equity derivatives, stock lending/repo, commodity (both physical and synthetic) and repackaging transactions. Much of his work revolves around the establishment of new transactions and regulatory issues associated with them, but he has also advised on issues with existing transactions and has recently worked on various aspects of the Lehman administration. 26