Credit derivatives traders and investors are awaiting the resolution of outstanding credit default swaps (CDS) on TXU Europe Group and market professionals say the outcome likely will set a precedent for how the CDS market responds to future bankruptcies. TXU Europe filed for bankruptcy in November but CDS contracts were written on TXU Europe Group.
The issue centers on a mid-February deadline by which buyers of CDS protection on TXU Europe Group must deliver obligations against their contracts in order to receive payment, or see their contracts expire worthless. What makes this situation unusual is that TXU Europe Group did not issue bonds or tap the loan market, and holders of CDS protection are therefore unable to deliver debt against their contracts. As a result, buyers of protection are hoping that TXU Europe's administrator, KPMG, will facilitate the sale of TXU Europe inter-company loans, which could then be used for the first time as a deliverable obligation against CDS contracts.
TXU Europe's bankruptcy filing was such a clear-cut case of a credit event that all dealers are believed to have triggered their CDS contracts, according to traders and lawyers.
"It's in everyone's interest to get this done," said one lawyer. But Phil Wallace, an administrator at KPMG who is working on the TXU case, said his role is only to document the inter-company loans and it is up to the sellers of protection to decide if they will pay out on the contracts. He described the amount of outstanding inter-company loans as "substantial." Wallace continued he's examining claims on a case-by-case basis, declining further comment.
A successful attempt by protection buyers to deliver the inter-company loans would be a boon for the credit derivatives market, demonstrating its flexibility, said an attorney. "Just because there is no publicly-issued debt doesn't mean buyers will lose their protection," he said. "There is a mechanism," he added.
This case highlights the need for legal due diligence when entering a credit-default swap contract, others said. "It was a bit surprising that a transaction was done on a reference entity without any tradable liabilities," said an attorney. "It's just plain stupid."
In the TXU case, it is in the administrators' best interest to make sure the loans would be deliverable because if they are sold, they will make money for the creditors of TXU Europe Group, one lawyer added.
