February 26, 2013 / 2:51 PM / 5 years ago

SNS Reaal potential test case for CDS changes

* 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 restructurings.

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 whammy.

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 the US.

“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 credit events.

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 meaningful remuneration.

“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 Citigroup.


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)

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