LONDON, Feb 5 (IFR) - The nationalisation of SNS Reaal looks
set to test the robustness of the process for determining
payouts on credit default swap protection, after the
International Swaps and Derivatives Association Determinations
Committee accepted a credit event question on Monday.
The Dutch Ministry of Finance announced last Friday it was
expropriating various SNS Reaal bonds, including Tier 1 and
Lower Tier 2 securities that will be fully written down.
While this should be a clear-cut CDS trigger once the
bondholders have been wiped out, there is a danger that inherent
flaws in the restructuring credit event could lead to CDS
holders not receiving appropriate payouts on the protection
"Based on the information available, the CDS should not have
triggered at this point in time. All that has happened is the
sub debt has been expropriated and there has been a non-binding
announcement that it will be converted into equity," said one
London-based derivatives lawyer.
"As and when the debt is written down the CDS should
trigger. The problem with that is that the bond won't then
exist, meaning it won't be deliverable into a CDS auction."
In the normal course of events, SNS Reaal's sub bonds would
be used in an auction process to determine a CDS payout that
should compensate for losses sustained on bond positions.
This works well for most CDS credit events except for debt
restructurings. There is a good chance the bonds in question
will already have been exchanged or written down before the CDS
auction can take place. This exposes a crucial flaw in CDS, as
protection holders are unlikely to receive a fair payout.
In the most high profile example, Greece's EUR100bn
restructuring last year, the payout on CDS following the auction
was in line with bondholder losses. Credit experts admitted this
result was a complete fluke because at the time of the auction
the new bonds traded at the same, depressed level (around 20) as
where the old bonds had been prior to the restructuring.
The new bonds have since rallied sharply.
ISDA has since vowed to fix the bond deliverability issue as
part of its overhaul of its credit definitions.
As the Dutch government will own the bonds, it will have the
final decision on how to handle a potential CDS trigger and
auction. It may well be a secondary consideration: in stark
contrast to the USD3.2bn of net notional outstanding at the time
of the Greek CDS trigger, SNS Reaal does not even figure in the
top 1000 CDS names, according to the DTCC.
"Beyond the credit event, there remains uncertainty on the
subordinated deliverable, given the bonds are no longer held by
investors," BNP Paribas analysts wrote in an investor note last
"However, they are owned by the Dutch government, unless
converted into equity or cancelled, on which we do not have any
ISDA may try to follow a tactic deployed in the
restructuring of some of the Irish banks, which it also tried in
Greece, but which was rejected by the authorities. This involved
ensuring that at least one liquid bond was not exchanged in the
restructuring until after a CDS auction could be held, in order
to provide a potential "old" bond that would be deliverable.
The London-based lawyer said delivering senior debt into the
auction may be another option, although this would be unlikely
to give an appropriate payout on the CDS as it will be trading
at a much higher price than the sub debt.
(Reporting By Christopher Whittall; editing by Alex Chambers
and Julian Baker.)