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France Telecom Deal Causes More Convertible Headaches

France Telecom's latest convertible bond offering has confused some European credit derivatives traders by once again bringing up the issue of whether convertibles can be delivered to holders of credit-default swaps in the event of a default. This time the issue revolves around the fine print on the EUR3.5 billion (USD3.1 billion) convertible bond the telecom giant issued last month. Some traders said convertibles from the deal should not be treated as deliverable because of a caveat in the deal's documentation, while others said the market appears to be treating the convertibles as deliverable and has ignored the fine print. Five-year default protection on the telecom company widened about 50 basis points to 180bps on news of the convertible, partly on the assumption it would be deliverable in a credit event.

The confusion comes in the first test case for convertible deliverability since the International Swaps and Derivatives Association's move early last month to clarify its definitions and state that convertibles are deliverable. But ISDA's amendment does not call for delivery in convertibles issued with a so-called mandatory exchangeable term, as in the France Telecom bond. However, Stacy Carey, a policy maker at ISDA in New York, maintained the France Telecom bonds would be deliverable.

Convertibles have come to the fore in the credit derivatives market since uncertainties over deliverability after the default of Railtrack. "Some people did think [France Telecom] is deliverable, but in other people's opinion this [caveat] renders it undeliverable," said one trader in London, whose bank participated in the bond offering. Another trader countered by saying, "no matter what the language in the deal, these bonds will be deliverable," because of ISDA's amendment and market convention. But he added: "There's still a fair amount of uncertainty."

Traders noted that although default spreads on France Telecom have tightened to their pre-deal level of around 130bps, it is difficult to determine whether any of this is because the market is treating the bonds as non-deliverable, given the market as a whole has tightened.

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