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Derivatives

Structured Credit Surge Spawns Documentation Slip-Ups

The rapid growth of innovative credit structures this year has given rise to a flood of documentation inaccuracies which, if tested by a credit event, could open a legal can of worms.

Claude Brown

The rapid growth of innovative credit structures this year has given rise to a flood of documentation inaccuracies which, if tested by a credit event, could open a legal can of worms. Less-sophisticated arrangers are adding trades such as leveraged super senior and synthetic asset-backed securities to their books, but overlooking legal nuances which distinguish them, said Claude Brown, a partner at Clifford Chance in London. He said shops which simply adapt CDS of ABS and leveraged super-senior documentation from other structures are increasing the likelihood of problems arising in the future. The issue of documentation is a pressing one in the wake of the regulatory spotlight on single name credit-default swaps by the U.S. Federal Reserve, particularly the legal ramifications of trade backlogs (DW, 9/30). Focus on structured credit documentation has been less intense, but with document replication across structures becoming a regular practice, problems are just as likely to occur, said one legal official. "Copying documents is the way technology gets around," said Brown. "Sometimes they don't match up and include something inappropriate."

Brown said in leveraged super-senior documents there could be problems in the legal relationship between a note holder and counterparty when a tranche is transferred to a third party. "You have to build in a channel of communication," he noted, adding, "The more complex the trade the more likely there will be problems." An in-house lawyer said there are always documentation issues with new products, but they are generally ironed out before legal difficulties arise.

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