Derivatives
CDS almost triples following controversial ruling
The latest twist in the legal battle between Argentina and hedge fund holdouts of its 2005 and 2010 bond exchanges has cast doubt on whether credit default swaps referencing the country’s debt may trigger.
US District Court Judge Thomas Griesa ruled on Wednesday that Argentina must pay holdouts when it comes to make regular payments to exchanged bondholders in December.
This will not apply to a US$42m coupon payment on new 2017 bonds on December 2, but a US$3bn payment due on December 15 to holders of GDP warrants and a US$200m coupon payment to discount bondholders on December 31 will not be able to proceed without also paying the holdouts.
GDP warrants do not count as a debt obligation as far as CDS are concerned, said Ian Harvey-Samuel, a partner with Shearman Sterling, so a missed payment on the warrants would not be relevant for protection holders. The question of whether CDS could still be triggered following a bond coupon payment made to the trustee, but not passed on to investors, is more of a grey area.
“There are different ways that Argentina might discharge the liabilities on their bonds that don’t necessarily result in payment to the bondholders. That’s not a particularly clear issue in the way that the trust indentures are drafted,” said Harvey-Samuel, speaking on Wednesday before the latest court ruling was made public.
In particular, the fact that Argentina is making payments to bondholders in December via a trustee (BNY Mellon) complicates matters. If Argentina made the payments to BNY Mellon, which opted against immediately passing the cash on to bondholders for fear of incurring the wrath of the court, it is not clear whether CDS would trigger as a result of a failure-to-pay credit event.
“The mere fact that the noteholders don’t receive payment doesn’t necessarily mean that there’s been a failure-to-pay on the bond; it would very much depend on the terms and conditions of the bond itself,” explained Harvey-Samuel. “Until we know what Argentina does and until it asserts its position with regard to the legal effect on its proper bonds, we don’t know whether or not CDS would trigger.”
Trading the trigger
Argentina CDS – which has a net notional outstanding of US$1.8bn, according to the DTCC – has become a major focus for emerging markets traders ever since the New York appeal court on October 26 upheld the view of Judge Griesa that old bondholders should be treated equally to those that had agreed to the restructuring.
Five-year CDS ballooned from 974bp on October 25 to a record wide of 2,589bp (or around 50 points upfront) on November 16, according to Markit. It then re-traced slightly on Monday, before widening again on Wednesday to 2,441bp at close. The US Thanksgiving holiday meant trading was more muted towards the end of the week.
“When it was known that BNY Mellon was going to be implicated in this, there was a concern that Argentina may make payment to bondholders in a way that could technically trigger CDS, which caused the CDS to gap wider,” said Sean Kelly, an EM credit trader at Credit Suisse, also speaking before the latest ruling was made public.
“Some of those reservations over CDS have since disappeared, but we don’t see accounts adding new risk positions here. We mostly see hedge funds taking profits on long protection positions on the back of the CDS widening.”
Some of the activity Kelly saw in the earlier part of last week related to some accounts selling one-month credit protection, taking the view that the court would not lift its stay and Argentina would be free to make its December payments to exchanged bondholders. Now, such bets could well turn sour, given the latest announcement.