VodafoneZiggo snafu shakes credit score derivatives market
Buyers are asking recent questions over whether or not the $8tn market in credit score derivatives gives any true safety towards debt default, after an obscure quirk threatened to render contracts regarding telecoms firm VodafoneZiggo fully nugatory.
The worth of about $600m value of credit-default swaps on the Dutch firm has tanked over the previous 4 days, almost a yr after issues first occurred with the contracts, that are designed to pay out if a borrower defaults.
The slip-up marks the most recent in a string of mishaps which have undermined confidence available in the market, notably since final yr introduced a high-profile furore over “manufactured defaults” by corporations — a money-spinning trick that drew condemnation from regulators on either side of the Atlantic.
“It’s yet one more instance of why CDS is a damaged product,” one hedge fund supervisor mentioned.
CDS written on VodafoneZiggo’s bonds act like an insurance coverage contract on the debt, paying out a lump sum if the corporate defaults. However market members have belatedly noticed the potential flaw, individuals accustomed to the matter mentioned, sending the price of the contracts falling to 164 foundation factors on Monday, after they started the month buying and selling at 290bp. Meaning it now prices an annual $164,000 to insure $10m of the debt towards default for 5 years.
The glitch stems from a collective failure of oversight within the CDS market, which sprang up within the early 1990s as a manner for banks to hedge their publicity to giant corporations.
It’s yet one more instance of why CDS is a damaged product
CDS contracts are written in extremely legalistic phrases and all the time relate to a particular entity inside an organization the place the debt sits. If bonds are moved round in a company reorganisation or a merger, nevertheless, this can lead to a phenomenon often called “orphaning”, the place the CDS contracts find yourself referencing an entity that not has any debt.
Usually, market members spot that the debt has been moved and flag it to supervisors inside 90 days. However within the case of VodafoneZiggo, the Netherlands’ largest cable operator that was fashioned in 2016, nobody seen unit beforehand backing the debt had been wound down in March 2018. The issue went undetected till the corporate filed a set of Dutch accounts final month.
One credit score hedge fund supervisor mentioned that up till final week, funding banks had been large consumers of the swaps, as these lenders have giant quantities of publicity to the telecoms firm that they’ve wanted to hedge.
“It’s one of the crucial traded names in the entire European high-yield CDS market,” mentioned the hedge fund supervisor.
For VodafoneZiggo, merchants are actually hoping that the Determinations Committee — the panel of representatives from banks and buyers that guidelines over disputes within the CDS market — could possibly repair the difficulty. That is the primary time the panel has needed to rule on whether or not it may well use a possible repair it devised in 2014, which might enable a brand new entity to imagine the legal responsibility.
The hedge fund supervisor mentioned he thought VodafoneZiggo’s CDS wouldn’t qualify for this simple resolution, nevertheless, as too many steps of company reorganisation had occurred earlier than the market woke as much as the issue.
“The unique entity doesn’t even exist any extra,” he mentioned.