Abstract
A central policy concern since the onset of the Greek debt crisis in 2010 has been whether sovereign debt restructurings trigger credit default swaps (CDS). For the first time since AIG threatened to default on its CDS in 2008, the Greek debt crisis returned CDS to the global spotlight. The question of whether sovereign debt restructurings trigger CDS matters not only for the buyers and sellers of CDS, but for financial stability more generally. Although there was universal agreement that a failure to pay when due would trigger a failure to pay credit event under CDS, whether formally voluntary/restructurings also trigger a restructuring credit event was uncertain before the Greek debt restructuring in March 2012. On the basis of the experience with the Greek restructuring, this article assesses how likely five restructuring techniques, ranging from simple bond exchanges to the use of collective action clauses, trigger CDS.
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REFERENCES AND NOTES
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See the timeline for DC decisions at http://dc.isda.org/credit-default-swaps-management/cds-timeline.
Bolton, P. and Oehmke, M. note42, (the empty creditor problem arises mainly in the pre-bankruptcy phase).
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Cf. also Lubben, S.J. (2007) Credit Derivatives and the Future of Chapter 11. Working Paper, Seton Hall University School of Law.
Bolton, P. and Oehmke, M. note42, 2648 (making (voluntary) restructuring a credit event constitutes one simple way of eliminating the empty creditor problem altogether … such that the CDS has no effect on the creditor's incentives in debt restructuring’ but doing so ‘also eliminates any economic gains from CDS as a commitment device’); cf. also Hemel100 (advocating a comprehensive restructuring credit event in all CDS).
Berndt, A., Jarrow, R.A. and Kang, C. (2007) Restructuring risk in credit default swaps: An empirical analysis. Stochastic Processes and their Applications 117: 1724–1749.
Issue Number 2009 – 100901, DC Americas, 6 November 2009 (6 ‘Yes’ and 9 ‘No’ votes), http://www.isda.org/dc/docs/200911062009100901DCDecision.pdf. The DC had earlier deferred its vote on this issue five times.
Issue Number 2009 – 100909, Decision of the External Review Panel (Grove, R. Schizer, D. Summe, K.), 14 December, http://www.isda.org/dc/docs/CEMEX_External_Review_Panel_Decision.pdf. Grove is CEO of Rutters Associates and was CEO of ISDA from 1997 to 2001; Schizer is Dean of Columbia Law School and Kimberley Summe is General Counsel of Partner Fund Management and former General Counsel of ISDA. The DC also selected Charles Whitehead, a Professor at Cornell Law School specialized in corporate and financial markets law, as the first alternative Potential External Reviewer.
ISDA, Japanese Determinations Committee, 30 March 2010, Issue No. 2009122402. A separate request whether a bankruptcy event had occurred in relation to the same filing was dismissed on the basis of insufficient publicly available information, 5 October 2009, Issue No. 2009100202, http://www.isda.org/dc/docs/Japan_Determinations_Committee_Decision05102009.pdf. As regards the general interest question submitted on Aiful, the Japanese DC concluded that no failure to pay credit event had occurred, Issue No. 2009101501, 19 October 2010.
Bolton, P. and Oehmke, M. note44, 2647; Packer, F. and Zhu, H. (2005) Contractual terms and CDS Pricing. BIS Quarterly Review, Quarter 3, 91, http://www.bis.org/publ/qtrpdf/r_qt0503h.pdf.
Foley-Fischer, note21, 58.
Eternity Global Master Fund Limited v. Morgan Guaranty Trust Company of New York and JP Morgan Case Bank, 375 F.3d 168 (2004).
Presidential Decree 1387, 1 November 2001, Title II, Article 17, quoted from Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co, 375 F.3d 168.
Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co., No. 02 Civ. 1312, 2003 WL 21305355, (S.D.N.Y. June 5, 2003), Eternity Global Master Fund Ltd. v. Morgan Guar. Trust Co., No. 02 Civ. 1312, 2002 WL 31426310, (S.D.N.Y. 29 October, 2002).
ISDA General Counsel David Green remarked that ISDA would consider the Greek restructuring as voluntary, and hence not triggering a credit restructuring event, even if it involved a lot of arm twisting. While it was ultimately a matter for the DC to consider, he emphasized that some holders of Greek debt ‘may well be between a rock and a hard place; that ‘officials have put significant pressure on banks to accept the deal’, and that this approach ‘sounds a bit like someone has made [bondholders] an offer they can’t refuse.’ When It Comes to Sovereign CDS, Collateral Is King, 29 November, 2011, isda.derivativiews.org.
[2010] EWHC 3372 (Ch).
BGHZ 116, 319, Abs. 18.
Invitation Memorandum dated 24 February 2012.
Greek Public Debt Management Agency, Press Release, 6 March 2012.
ISDA General Counsel David Green: ‘a CDS is really trying to catch an actual default or something that is very close to a default, and we never thought that a voluntary exchange came that close to a default for CDS purposes’. http://www.cnbc.com/id/43640540/Greek_Debt_Rollover_Wont_Trigger_Default_Swap_ISDA_Counsel; ISDA, Greece Sovereign Debt FAQ, http://www2.isda.org/greece-sovereign-debt-faq/ (‘the Eurozone proposal is voluntary and not binding on all bondholders. As such, it does not appear to be likely that the deal will trigger payments under existing CDS’); Academics also entered the debate, cf. Darrell Duffie, ‘I have very little doubt that they will be triggered’, New York Times (2012) Greek Crisis Raises New Fears over Credit Default Swaps, 21 February.
When It Comes to Sovereign CDS, Collateral is King, November 29, 2011 isda.derivativews.org.
Issue Number 2012022401, 22 February 2012. Does the announcement of the passage by the Greek parliament of legislation that approves the implementation of an exchange offer and vote providing for collective action clauses (‘CACs’) that impose a ‘haircut amounting to 53.5%’ (MINFIN Announcement, 2.21.2012) that ‘shall bind the entirety of the Bondholders [of eligible instruments]’ (First Article, Section 9), constitute a Restructuring Credit Event in accordance with Section 4.7 of the 2003 ISDA Credit Derivatives Definitions (as amended by the 2009 ISDA Credit Derivatives Determinations Committees, Auction Settlement and Restructuring Supplement to the 2003 ISDA Credit Derivatives Definitions, published on 14 July, 2009) because (i) the European Central Bank and National Central Banks benefitted from ‘a change in the ranking in priority of payment’ as a result of the Hellenic Republic exclusively offering them the ability to exchange out of their ‘eligible instruments’ prior to the exchange and implementation of the CACs, thereby effectively ‘causing the Subordination’ of all remaining holders of eligible instruments, and (ii) this announcement results directly or indirectly from a deterioration in the creditworthiness or financial condition of the Hellenic Republic?
Issue Number 2012022901, 29 February 2012, Does (i) the agreement that has been reached between the Hellenic Republic and a number of private sector holders of Greek debt (the ‘PSI Agreement’) to vote in favour of the invitation described in the Invitation Memorandum dated 24 February 2012 by the Hellenic Republic to the holders of each series of securities listed in the Invitation Memorandum (the ‘Designated Securities’) to offer to exchange the Designated Securities for new securities (the ‘Invitation’); (ii) the enactment of Article First of Law No. 4050/2012 (Government Gazette A 36/2012), ‘Rules on the modification of titles issued or guaranteed by the Greek State with the Bondholders’ agreement’ (the ‘CAC Law’) and (iii) the statement by the Ministry of Finance of the Hellenic Republic on 21 February 2012 that the CAC Law can be used together with the PSI Agreement to achieve participation in the offer described in the Invitation at the levels anticipated by the 26 October 2011 Eurozone Summit Statement, constitute a Restructuring Credit Event in accordance with Section 4.7 of the 2003 ISDA Credit Derivatives Definitions (as amended by the 2009 ISDA Credit Derivatives Determinations Committees, Auction Settlement and Restructuring Supplement to the 2003 ISDA Credit Derivatives Definitions, published on 14 July, 2009) because (i) a reduction in the amount of principal or premium payable at maturity or at scheduled redemption dates of the Designated Securities has been agreed between the Hellenic Republic and a sufficient number of holders of the Designated Securities to bind all holders of the Designated Securities and (ii) this agreement results directly or indirectly from a deterioration in the creditworthiness or financial condition of the Hellenic Republic?
Oakely, D. and Pollack, L. (2012) Greek credit swap ruling divides investors. Financial Times, 9 March.
Hope, K., Milne, R. and Spiegel, P. (2012) Creditor group to take part in Greek swap. Financial Times, 5 March (a payment of 75 per cent prior to the restructuring compared to a payment of 50 per cent of the face value of the debt after the restructuring).
Oakley, D., Chaffin, J. and Milne, R. (2012) Greek debt swap triggers massive payouts. Financial Times, 9 March (quoting Robert Pickel, Chief Executive of ISDA: ‘a credit event could not be triggered until it was binding on all holders of the bonds. It would have been premature to trigger a credit event before now.’).
EMEA DC, Issue No. 2010 – 122201, Anglo Irish Bank-Corporation Limited, 23 November 2010 (15:0).
‘In light of the severity of the liquidity crisis confronting it, Ukraine is not in a position to, and will not, make any offer to holders of the Existing Notes other than this Exchange Offer. Ukraine will not entertain any settlement with holders of Existing Notes who elect not to participate in this Exchange Offer on terms which are more favourable than those contained in this Exchange Offer’. The Cabinet of Ministers of the Ukraine, Offers to Exchange €10 per cent. Amortizing Notes Due 2007 or $1 per cent. Amortizing Notes Due 2007, 9 February 2000, quoted from Buchheit, L.C. (2002) The search for intercreditor parity. Law and Business Review of the Americas 73 (8): 73–80, 77.
Gulati, M. and Zettelmeyer, J. (2012) Engineering an Orderly Greek debt restructuring. 29 January, Mimeo, 6 (an exchange in the shadow of CACs conditional on meeting a minimum participation threshold is unlikely to trigger CDS); but cf. Oakley, D. and Hope, K. (2012) Greek Debt swap pay-out prospect weighted. 22 February (pay-outs on Greek sovereign CDS are likely to be triggered because CACs are to be inserted into Greek bonds).
DC EMEA, Issue Number 2012022901, 29 February 2012.
Republic of Ireland, Issue Number 2011031101, 11 March 2011; The Hellenic Republic, Issue Number 2012022401, 22 February 2012 (ECB and national central bank priority).
Paragraph (13) of the Preamble of the ESM Treaty provides: ‘ESM loans will enjoy preferred creditor status in a similar fashion to those of the IMF, while accepting preferred creditor status of the IMF over the ESM. This status will be effective as of the date of entry into force of this Treaty’.
CDS transactions became subject to the DC process by virtue of the 2009 ISDA Credit Derivatives Determinations Committees, Auction Settlement and Restructuring Supplement (DC Supplement).
ISDA Credit Derivatives Determinations Committee Rules, 11 July 2011, http://www.isda.org/credit/docs/DC_Rules_(July-11_2011).pdf.
Groehndahl, B. (2012) Austria's Kommunalkredit. KA Finanz Bring €455 Million to Greek Swap, Bloomberg, 8 March.
Section 13, 2002 ISDA Master Agreement; Section 13 of the 1992 ISDA Master Agreement contains a similar jurisdictional clause, though without express reference to non-exclusive jurisdiction of the English courts. The 2002 version of the Master Agreement was amended to reflect Article 17 of the Brussels and Lugano Conventions on jurisdiction and enforcement of judgments.
Section 13 (a) of the 1992 ISDA Master Agreement is formulated in identical terms.
Murray, E. (2012) Lomas v. Firth Rixson: A curate's egg? Capital Markets Law Journal 7 (1): 5–17.
Part 4(h) Schedule to the 2002 Master Agreement. The formulation in Part 4 (h) of the 1992 Schedule to the 1992 Master Agreement is identical.
Issue Number 2011 – 111401, Seat Pagine Gialle SpA, 28 November 2011 (8:7, failure to pay), sent to external review by the same decision, but withdrawn on 1 December 2011 from the External Review Panel after the EMEA DC found in relation to another request on the same date that a failure to pay had occurred (15:0), Issue Number 2011 – 120101, 1 December 2011.
Pollack, L., Wigglesworth, R. and Oakley, D. (2011) Questions over CDS amid pay-out wrangle. Financial Times, 29 November; Wiggelesworth, R. and Pollack, L. Seat Pagine dispute triggers test for corporate CDS, November 28, 2011 (the second time an ISDA DC failed to reach the required majority).
ISDA, The ISDA Credit Derivatives Determinations Committees, May 2012, 3 (for the last 10 credit events, the average DC deliberation time was 1 day in the Americas, and 3 days in Europe).
Statement by the Steering Committee of the Private Creditor-Investor Committee for Greece (PCIC), 5 March 2012, http://www.iif.com/press/press+236.php; for the current composition of ISDA DC see #http://www.isda.org/dc/committees.html#EMEA. Conflicts of interest arise may also arise when a law firm represents CDS protection buyers and sellers, and, at the same time, other actors in the DC process or creditors whose interests run counter to those of CDS protection buyers.
Burne, K. and Lauricella, T. (2012) Hushed up: Secret panel holds fate of Greek CDS. The Wall Street Journal, 29 February (highlighting concerns by some that the process is shrouded in secrecy, with no participation by outsiders, no transcript of the meeting, no requirement to provide any explanation, no ability to appeal and with the names of the member representatives undisclosed).
Schneider, H. (2012) For Greece, a critical conference call between London and New York. The Washington Post, 1 March.
ISDA The ISDA Credit Derivatives Determinations Committees, May 2012, 4.
See note56 above.
E.g. Article 6 of the European Convention on Human Rights – the subject matter of disputes arising out of CDS are generally civil matters.
ISDA, The ISDA Credit Derivates Determinations Committees, May 2012, 1, 4.
Lee v. Showmen's Guild of Great Britain [1952] 2 Q.B. 329; Scott v. Avery, (1856) 5 H.L. Cas. 811; Leigh v. National Union of Railwaymen (review of decision of General Secretary of National Union of Railwaymen to exclude the applicant on the grounds of being a member of a prescribed party); cf. also Beale, H.G. (ed.) (1999) Chitty on Contracts, General Principles, 28th edn. London: Sweet and Maxwell, 17-045-17-046.
Lee v. Showmen's Guild of Great Britain, 341.
Lee v. Showmen's Guild of Great Britain, 342.
Wigglesworth, R. and Pollack, L. (2011) Seat Pagine Dispute triggers test for corporate CDS. 28 November, (reporting ‘mounting concerns over the usefulness of CDS as insurance contracts against default’).
Oakley, D. and Patel, K. (2011) Sovereign CDS soar for big Eurozone countries. 15 November, Financial Times (the ‘three peripheral markets of Ireland, Greece and Portugal are seeing minimal trading … bankers said CDS spreads had risen as volumes fell because fewer funds were prepared to sell protection as a result of worries that sovereign defaults will not trigger pay-outs after politicians urged banks to take part in writedowns of Greek debt voluntarily’.).
Oakley, D., Chaffin, J. and Milne, R. (2012) Greek debt swap triggers massive payouts. Financial Times, 9 March.
Prior to the March 2012 decision on the Greek debt restructuring, Fitch expressed the need for the CDS documentation to be ‘revisited’. ‘It would seem that the use of the restructuring credit event generally and the nature of the language employed should probably be revisited’ in view of the substantial prospective impairment of the holdings of Greek creditors, without triggering a credit restructuring event. Mackenzie, M. (2011) Fitch backs calls for sovereign CDS reform. Financial Times, 27 November.
Duffie, D. and Thukral, M. (2012) Redesigning credit derivatives to better cover sovereign default risk. Rock Centre for Corporate Governance, Working Paper Series No. 18, 6 May (noting the anomaly that CDS payouts could decrease the more aggressive a sovereign debt restructuring, given that bond prices could rise following a successful restructuring due to the reference entity's improved creditworthiness, and suggesting that the actual package received by tendering creditors count as deliverable).
ISDA, The Use of Arbitration under the ISDA Master Agreement, 19 January 2011, http://www.isda.org/uploadfiles/_docs/FLRC_ISDA_Arbitration_Memo_Jan11.pdf, ISDA, The Use of arbitration under the an ISDA Master Agreement: feedback to members and policy options, 10 November 2011, http://www2.isda.org/attachment/Mzc0NQ==/Arbitration_ISDA_memo_Pt2_Nov11_Final.pdf.
Acknowledgements
I thank Dalvinder Singh for organising the conference that inspired this article, Tobias Lehmann for assisting in its preparation, and Mitu Gulati, Edward Murray and Daniel Peat for discussions. All views expressed herein are my own.
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Waibel, M. Steering sovereign debt restructurings through the CDS quicksand. J Bank Regul 15, 14–40 (2014). https://doi.org/10.1057/jbr.2012.17
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DOI: https://doi.org/10.1057/jbr.2012.17