* Compensation claims could be delivered into CDS auction
* ISDA Determinations Committee to meet Wednesday
* Lessons from SNS Reaal to feed into CDS overhaul
By Christopher Whittall
LONDON, Feb 26 (IFR) - SNS Reaal could be used as a test
case for a crucial alteration being planned for credit default
swap contracts that experts say is needed to ensure fairer
payouts for protection holders in light of more aggressive debt
Ensuring that securities other than bonds can be delivered
into CDS auctions - often referred to as an "asset package" - is
one of the key changes that the International Swaps and
Derivatives Association (ISDA) is expected to make to its new
credit definitions set to be released later this year.
The plight of SNS Reaal bondholders serves as a stark
reminder of why the changes are needed, as the Dutch
government's shock decision to expropriate all of the bank's
subordinated debt could hit junior investors with a double
As well as losing out completely on their cash position,
investors may find their CDS protection is also worthless due to
the disappearance of the sub bonds, which would usually be used
to calculate CDS payouts.
David Geen, ISDA's general counsel, said he was not aware of
any discussions around the possibility of delivering an asset
package of compensation claims against the Dutch government into
the SNS Reaal CDS auction in lieu of the expropriated bonds, but
signalled the option was not off the table.
"Under the CDS Definitions, it is within the power of the
Determinations Committee (DC) to specify other assets as
deliverable by amending the Auction Settlement Terms," said
Geen, who pointed to a precedent from a previous credit event in
"That said, the DC may be wary about doing so, and it would
require a broad consensus."
Like others before it - including the high profile case of
Greece - SNS Reaal has exposed a potential flaw in restructuring
The current ISDA credit definitions only permit bonds to be
delivered into CDS auctions. As a result, credit experts say the
most likely outcome is that SNS Reaal's senior bonds are used to
calculate CDS payouts. The problem is that senior bonds are
trading around par, meaning protection holders would receive no
"The concern in SNS is that the CDS contracts may not
function properly in this case and, more importantly, in
future restructurings of other banks," said Michael
Hampden-Turner, credit strategist at Citigroup.
"The fear is this scenario might be repeated throughout
Europe and it could put people off holding sub debt. There is a
general concern policymakers are no longer bothered about the
CDS market anymore."
One possible solution is to allow other securities to be
delivered into the auction instead, if the bonds have already
been wiped out or exchanged for other securities.
James Duncan, a partner at Shearman & Sterling, highlighted
that SNS Reaal investors have the right to claim compensation
against the Dutch government. These claims, like the SNS Reaal
subordinated bonds, are likely to be valued at zero.
In principle, if the CDS definitions allowed it, the
compensation package could be valued, which could then be used
to calculate the CDS payouts, said Duncan.
"The question is whether ISDA will allow a security to trade
which represents the compensation claims of bondholders. That
does not fit with the current definitions and would mean ISDA
would have to stretch the contract," said Hampden-Turner at
ISDA's DC is due to meet on Wednesday to decide whether one
or more CDS auctions on SNS Reaal will be held.
The number of outstanding CDS on the bank does not even
figure in the top 1,000 names on the DTCC website, meaning that
the outstanding amount likely clocks in at below USD50m - a drop
in the ocean in the USD27trn CDS market.
Even so, whatever the decision, it seems a number of lessons
from the nationalisation of SNS Reaal will be used to further
improve CDS contracts.
"The volumes of SNS Reaal CDS are very small - people see it
as a test case. We are still in the process of updating the
credit definitions with the aim of finalising in mid-2013, and
what happens in SNS Reaal will get rolled into that as well,"
said ISDA's Geen.
For instance, there is a working group at ISDA that will
look specifically at whether the credit definitions could be
updated to take into account bail-in of senior and sub debt.
While CDS on SNS Reaal were judged by a majority of 14 to
one to have triggered, Geen said clarifying the definitions so
that a nationalisation or expropriation of debt is a credit
event may be considered.
Elsewhere, Geen poured cold water on the idea that ISDA may
be preparing to engage in talks with the Dutch government to
release at least one liquid bond that could be deliverable into
a CDS auction - a tactic used in the Irish bank restructurings
and discussed in Greece.
"ISDA has had no discussions along these lines - the Dutch
government owns that debt now," said Geen.
Either way, CDS practitioners will be watching the DC's
deliberations closely. While the measly amount of CDS
outstanding should ensure the outcome of SNS Reaal has no
meaningful economic impact, the wider implications for the
market could be significant.
(Reporting By Christopher Whittall; Editing by Natalie
Harrison and Julian Baker)