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Thursday, 18 April 2019

One-word change triggers Abengoa CDS split

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ISDA’s credit determinations committee has confirmed that a one-word change in new credit default swap definitions led to a surprise split decision on Abengoa that will trigger payouts on credit default swap contracts issued under the 2003 definitions, but not on those under 2014 definitions.

The only change between 2003 definitions (updated in 2009 as a result of Big Bang and Small Bang protocols) and the latest 2014 version is the move of the word “similar”.

The 2003/2009 version, which the determinations committee ruled was satisfied by Abengoa’s filing, notes any reference entity that institutes or has instituted against it “a proceeding seeking a judgement of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights.”

In the 2014 definitions, the word “similar” has been moved to refer to relief rather than law. It now reads as “a proceeding seeking a judgement of insolvency or bankruptcy or any other similar relief under any bankruptcy or insolvency law or other law affecting creditors’ rights.”

That distinction was crucial to the split decision. Abengoa’s “Article 5bis” filing was “pre-concurso” which confirms the company’s intention to enter a restructuring within the next four months.

Even though it is part of Spanish insolvency law, a pre-concurso filing is not “similar” to providing insolvency relief as the company is not granted relief until it actually embarks on restructuring.

”The DC was (in the majority) of the view that the relief granted by the filing of the Article 5bis communication is not a relief sufficiently similar in effect to that of a judgment of insolvency or of bankruptcy,” ISDA said in a statement on its website. The vote against a credit event under the 2014 definitions was 14 to one, with Citadel the only dissenter.

ISDA goes on to say that ”filing an Article 5bis communication does not suspend payment obligations, and prevents neither acceleration of obligations nor the bringing of a claim.”

Not so similar

The wording was changed in the new definitions to address the fact that under the 2003 documents, CDS could potentially trigger without an actual default. Under the old ruling, an attempt to seek any legally-recognised form of bankruptcy protection would constitute a credit event, even if that protection was not required and payments continued to be made.

Ultimately the 2014 definitions recognise the breathing room afforded to issuers to negotiate a consensual restructuring with creditors, which forms the basis of amended Spanish insolvency law, while the 2003 definitions do not.

Spanish insolvency law was amended in March 2014 to allow viable companies to restructure debt in a sustainable manner, while enabling creditors to maximise their recovery.

On that basis, 2014 contracts could be triggered within the next four months, when the company enters restructuring or if further failure-to-pay information emerges.

The decision on Tusday created confusion among market participants and legal experts, many of whom do not see enough distinction to warrant different outcomes.

“We have no idea why ISDA would have done that,” said a credit strategist at one US house immediately following the split decision. “We can’t see any reason why the 2003 definitions would apply and not the 2014 defs.”

The biggest change to definitions was made in section 4.2(c), which refers to a “general assignment, arrangement or composition with or for the benefit of its creditors.”

However, that definition was broadened in 2014 to refer to creditors “generally” and added “or such a general assignment, arrangement, scheme or composition becomes effective.”

CDS credit event determinations are chequered with surprising outcomes, in part due to changing insolvency laws.

“However good the definitions are, ultimately you’re dealing with hundreds of different insolvency laws and you can’t legislate for everything, particularly when new insolvency laws are drafted, and sometimes in response to the definitions,” said Edmund Parker, co-head of the derivatives and structured products group at Mayer Brown.

The majority of the US$675m net notional in outstanding CDS contracts referencing Abengoa is believed to be under the later 2014 definitions as the name was included in a protocol that enabled participants to transfer into new contracts.

Some 2003 contracts are still outstanding, primarily as part of credit-linked notes, or as part of legacy special purpose vehicle entities that are not operated on a day-to-day basis.

However, it is expected that there may not be enough 2003 contracts outstanding for an auction to be held. In that case, payouts would be determined privately.

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