As a general matter parties to privately negotiated derivative transactions
are free to include or exclude any contractual provision as mutually
agreed. ISDA should not establish any market standards on which terms and
conditions must be included in any privately negotiated agreement, but it
should provide alternatives that parties may choose to use, not use, or
modify.
As it relates to Restructuring in the Credit Derivative Definitions,
parties are free to include or exclude it as a Credit Event. The Credit
Portfolio Management Group recognises that the market may develop in a
"two-tiered" fashion whereby Credit Derivative Contracts trade with and
without Restructuring as a Credit Event. However, as a practical matter,
many banks that use Credit Derivatives as a tool to manage their firms' own
credit risk require that Restructuring be included as a Credit Event. This
requirement may be due to internal credit policies or regulatory
considerations.
The current definition of Restructuring is considered by Sellers of
protection as too damaging when the triggering event is solely a Loan
Restructuring. The damage to the Sellers of protection is primarily due to
the option that Buyers have to deliver any bond or loan with a maturity of
up to 30 years as settlement of the Credit Derivative contract. Recent
events in the marketplace have confirmed these fears.
Given that many Buyers of protection will require Restructuring as a Credit
Event and that Sellers of protection feel the current definition is too
heavily tilted towards the Buyers, the Credit Portfolio Management Group
feels that the current definition needs modification. These proposed
changes seek to meet the majority of the legitimate but divergent concerns
expressed by Sellers and Buyers. Our proposal would make the following
changes:
1. In Section 4.7, delete item (iv). Item (iv) deals with subordination.
There has been substantial confusion among market participants regarding
this issue, and interpretations of this aspect of the ISDA Restructuring
definition have differed substantially. This provision currently requires,
at least in non-sovereign situations, an express, consensual agreement by
holders to subordinate their Obligation. A structural, or de facto
subordination of one type of Obligation as a result of amendments to
another Obligation of the Reference Entity, causing a decline in relative
value, would not itself constitute a Restructuring under clause b(iv) of
the current Restructuring definition. Since a consensual subordination,
not coupled with any one or more of the changes specified in b(i) - (iii)
is not likely to occur in most cases, we believe this item can be removed
from the definition. In addition rating agencies do not consider
subordination to be a Credit Event. However, in light of the confusion
surrounding subordination in relation to the "Pari Passu Ranking"
Deliverable Obligation Characteristic, we urge ISDA to take this
opportunity to clarify the issue. As currently written, in a credit
derivative in which this Characteristic is applicable, the Definitions
would exclude any otherwise eligible Deliverable Obligation which became
subordinated after the trade date of the transaction. We suggest that an
obligation which satisfies "Pari Passu Ranking" on the trade date of a
credit derivative but which loses that status in connection with a
Restructuring (modified as suggested in this proposal) would remain an
eligible Deliverable Obligation.
2. In Section 4.7 (b) add language which would exclude bilateral, or
single lender bank debt and exclude actions taken by the bank lending group
that do not require at least a supermajority to agree. Restructuring would
not apply for bilateral loans and amendments to a loan agreement that only
require a simple majority vote. We understand that Sellers are
particularly concerned about vesting a single hedger/lender with the
ability to create a triggering event. Limiting Restructuring to
multi-lender situations provides a more reliable likelihood that a
Restructuring is a valid indicator of a Credit Event since it is accepted
by lenders with varied objectives. In cases where a Buyer is hedging a
bilateral loan, such as those credits which are effectively agented by
borrowers with a series of bilateral loans, language to include bilaterals
can be agreed by the parties to the particular default swap. In the spirit
of offering a broadly usable, credible compromise, we believe this is the
most constructive approach.
3. Add a definition of a Restructured Loan. This is needed to
distinguish the more narrow terms which are being suggested for settlement
triggered by Restructuring of Loans.
4. Modify the Settlement process if the Credit Event being cited is a
Restructuring of a Loan. We note that the ISDA definitions contemplate
that a single Credit Event is cited in a Credit Event Notice. Where
multiple Credit Events may have occurred, in practice, the Notifying Party
would cite the most clearly demonstrable of such events. But in cases
where Restructuring based upon a Loan is cited, we propose narrower
settlement provisions. If the Buyer triggers, the Seller may require that
the Buyer deliver only the Restructured Loan. If the Seller triggers, then
the Buyer may deliver whatever the contract allows. We feel that this will
prevent ?gaming? by either the Buyer or the Seller.
5. Allow for an Alternative Settlement method if the proper consents to
assignment of the Restructured Loan are not obtained in a timely fashion.
If delivery of the Restructured Loan cannot be achieved within the Physical
Settlement Period (Section 8.5 of the Definitions) due to the non-receipt
of required consents, then delivery would be effected via a new
?restricted? Credit Derivative. The Buyer of the triggered Credit
Derivative would be the Buyer of the restricted Credit Derivative. The
restricted Credit Derivative would be limited to the Restructured Loan
i.e., it would have as Reference Obligation the Restructured Loan. In
addition, the restricted Credit Derivative would be written to the final
maturity of the Restructured Loan and it would pay the contractual ?all-in?
drawn spread (e.g., including applicable Facility Fees, etc.) on the
Restructured Loan. If a Credit Event occurs while the restricted Credit
Derivative is outstanding, the Deliverable Obligation would be the
Restructured Loan (a Restructuring Credit Event would imply replacement or
restatement of the restricted Credit Derivative.) Importantly, the
restricted Credit Derivative would be canceled and immediately replaced
with an assignment of the Restructured Loan if consents to assignment are
subsequently obtained. Also, if consent requirements fall away persuant to
the occurrence of other Credit Events (such as Failure to Pay), under the
applicable loan documentation, the parties would proceed with physical
settlement by assignment of the Restructured Loan. This approach,
cancellation of the restricted Credit Derivative when consent is obtained
or such requirements fall away, reflects the fact that consents are likely
to be received in due course and the ultimate intention is to effect
Physical Delivery of the Restructured Loan. Entering into the restricted
Credit Derivative only ensures that the Buyer is able to maintain the
protection of the triggered Credit Derivative in the event that consents
are not immediately received. Additional requirements that certain
participants may need, such as the posting of collateral, can be addressed
during the negotiation phase of the original transaction.
6. In evaluating these proposed modifications, issues relating to other
provisions in the Definitions unavoidably arise. Many of these issues are
being discussed by market participants, either as items which should be
reconsidered or revised. In an effort to avoid distracting the critical
need to reach a satisfactory compromise on Restructuring, we believe it is
preferable to address these other issues separately. They should be open
for discussion as ISDA considers a User's Guide and other proposed
revisions to the Definitions
