This week's Guest Column was written by a derivatives lawyer in London who wishes to remain anonymous.
The major credit derivative dealers will shortly start to deliver credit event notices to sellers of credit protection on Marconi plc. The clause that will trigger the swaps is:
Marconi had taken action in furtherance of or indicating its consent to, approval of, or acquiescence in, making a general assignment, arrangement or composition with or for the benefit of its creditors.
In order to prevent syndicate banks and bondholders from withdrawing support, forcing Marconi into insolvency, Marconi has taken action to remove a requirement for an approval by shareholder vote as part of its restructuring. The Financial Services Authority in the U.K. has set out the conditions to achieve the waiver and Marconi is expected to meet them.
The arrangements required for the credit event are the proposed Companies Act 1985 scheme of arrangement for Marconi Corp. plc, the debt incurring subsidiary of Marconi plc, and the proposed "all creditors' scheme of arrangement" of Marconi plc. Marconi announced the proposed schemes of arrangement in a press release on Aug. 29.
Linklaters has provided a legal opinion that endorses the view that a credit event has occurred on both Marconi plc and Marconi Corporation plc.
After a credit event the protection seller has to pay the buyer the notional amount, usually USD10 million, in return for Marconi bonds or loans with the same face value.
Most default protection on Marconi uses three types of event which can trigger a payment. These are: failure to pay: Marconi doesn't pay either the interest or the principal on any of its outstanding debt; restructuring: Marconi enters into a binding arrangement with its creditors to adversely change the terms of any of its outstanding debt; and bankruptcy: this includes a sub-set of events that indicate that Marconi is or is about to suffer insolvency proceedings or insolvency related action.
The bankruptcy clause is the event which will trigger the protection in this case. The buyer will have to support the credit event notice with publicly available information, such as a press report or information released by the distressed company. In this case, the Marconi press release will be used.
The Impact Of Default Swaps
As credit-default swaps have become widespread and the number of contracts has increased, they have started to have an effect on the outside world. Many of Marconi's loan and bond holders had bought credit protection. This gives them a dual point of view. On one hand they are interested in meeting with Marconi and arranging the most preferential terms in any restructuring, but on the other they don't really care because they have bought protection and they can deliver their debt to sellers of protection without suffering any loss. The modern and wholly novel challenge, therefore, is to manage these two competing interests often personified by different trading desks within the same financial institution. There is also no Chinese Wall between these two desks and they are often run by the same person.
From Marconi's perspective there is the prospect of watching helplessly while the creditors around the negotiating table, who they have built relationships with over the last several years, become involved in an elaborate game of musical chairs. A credit event occurs and the debt of Marconi now starts to move from institution to institution before settling on the end-user, the entity that sold more protection than it bought. At this point, Marconi can expect to look up at its bondholder's committee and its syndicate bank group and find them substantially changed. The question then becomes, will these new creditors endorse the indicative restructuring agreed by their predecessors, will they have the same skill-sets and interest in maintaining the struggling company or will they be aggressively short-term in their outlook and withhold agreement preferring Marconi to go into bankruptcy or else demand that the terms of the restructuring be re-negotiated? Only time will tell.
A credit-default swap normally allows the buyer to deliver its debt at any time within a period of approximately 60 days. Bonds take just a matter of days to deliver while loans take only slightly longer. Meanwhile, Marconi does not even intend to distribute the restructuring agreements necessary to make its initial discussions anything other than indicative until November. Without these agreements the restructuring cannot proceed.
