This week market makers will start thrashing out how to tackle the increasing problem of credit-default swaps, which wipe out when the underlying debt is restructured. An overhaul to CDS documentation language is the most obvious resolution, say officials who will be discussing the issue on a dealer conference call this week. Other ideas being thrown around include changes to coupon payments on a succession event and even dealer polls to determine if the debt must be retired or passed over to the new entity.
Jitters on the Street about this problem--termed CDS orphaning--have spiked because of an upsurge in corporate takeover activity in Europe. It has raised fears a swathe of issuers will retire bonds, leaving protection buyers with no succeeding deliverables and collapsing spreads on the name. "People are terrified," said one London-based CDS trader.
Wednesday's call will be hosted by the International Swaps and Derivatives Association and is part of a fact-finding mission to map out the vast web of circumstances under which successor problems could arise, said Louise Marshall, spokeswoman for ISDA in New York. She said there is a view to add a supplement to the 2003 credit derivative definitions which will amend so-called successor language.
Although an orphaned CDS only directly impacts the user who is long protection/short the bond, credit officials say the issue is a pressing one for the whole market. "We want to make sure someone will always be there to buy the market shorts," said a credit researcher at a London-based hedge fund. To date, there have been a number of orphaning incidents, including Rentokil, Axel Springer/ProSieben (DW, 10/28/05), ITV-Carlton, WPP Group, BCP Caylux and Stagecoach.
