On February 21, the International Swaps and Derivatives Association, Inc. (“ISDA”) announced the publication of the 2014 ISDA Credit Derivatives Definitions (the “2014 CD Definitions”), which amend several terms that existed in the 2003 version of the definitions, and introduce several new terms based on “lessons learned.”
The most important new terms in the 2014 CD Definitions are in response to events affecting financial institutions and sovereign entities that have occurred since the introduction of the 2003 version of definitions, including governmental interventions in bank debt. These new terms include an entirely new credit event known as “Governmental Intervention,”[1] which is intended to be triggered upon a government-initiated “bail-in”[2] or debt restructuring, as well as a provision for delivery of instruments resulting from a government-initiated debt exchange.
In recent years, concerns have been expressed that the credit event for “Restructuring” may not cover certain measures actually taken by governments to support struggling entities, especially banks. For example, there was uncertainty as to whether a Restructuring had been triggered by the February 2013 nationalization of SNS Bank NV, the fourth largest bank in the Netherlands, by the Dutch government and the expropriation of all of its subordinated bonds.[3] This uncertainty was caused primarily because “expropriation” was not expressly included as a triggering event in the 2003 definition of Restructuring.
The Governmental Intervention credit event is intended to fill this gap in protection. Governmental Intervention is defined to include actions or announcements by a “Governmental Authority”[4] that result in, inter alia, the reduction in the rate or amount of interest payable by a reference entity, an expropriation or other event which mandatorily changes the beneficial holder of the relevant obligation, or a mandatory cancellation, conversion or exchange. This event is similar to Restructuring in certain respects (for example, the reduction in the rate or amount of interest of an obligation may trigger both events). However, unlike Restructuring, deterioration in creditworthiness is not required to trigger the Governmental Intervention credit event.
In addition to the new credit event, the 2014 CD Definitions also introduce the ability to settle certain credit events by delivery of assets into which debt is converted. This change was prompted, at least in part, by Greece’s 2012 debt restructuring, in which the Greek government used a “collective action clause” under domestic law to exchange certain debt before an auction to settle credit default swaps could be held. A final settlement price for contracts is typically determined by holding an auction for the defaulted bonds. The result of the debt exchange was that there were fewer bonds constituting “deliverable obligations” for purposes of the auction. As we have previously highlighted, credit protection buyers were spared serious losses in connection with the credit event caused by the Greek debt restructuring because the price for the new bonds delivered at the auction closely approximated the level of loss sustained by private investors on the old bonds.[5] Nevertheless, the Greek debt exchange highlighted the need to address a potential disconnect in prices under similar circumstances in the future.
In response, the 2014 CD Definitions provide for new “Asset Package Delivery” provisions. These provisions generally apply upon the occurrence of an “Asset Package Delivery Event,” which is defined to include events such as a Restructuring with respect to a sovereign entity. Under the new provisions if, for example, a sovereign Restructuring credit event occurs, the assets that will be deliverable into an auction will be based on “Package Deliverable Bonds,” which are obligations that qualified as deliverable obligations at the time the Asset Package Delivery Event became effective and that are selected by ISDA based on certain specified criteria and published on its (or a third party designee’s) website.
ISDA has stated that it expects market participants to begin confirming transactions using the 2014 CD Definitions starting in September 2014. A protocol will also be established to allow parties to utilize the 2014 CD Definitions for existing transactions.
[1] This new credit event, is defined as follows:
“(a) ‘Governmental Intervention’ means that, with respect to one or more Obligations and in relation to an aggregate amount of not less than the Default Requirement, any one or more of the following events occurs as a result of an action taken or an announcement made by a Governmental Authority pursuant to, or by means of, a restructuring and resolution law or regulation (or any other similar law or regulation), in each case, applicable to the Reference Entity in a form which is binding, irrespective of whether such event is expressly provided for under the terms of such Obligation:
(i) any event which would affect creditors’ rights so as to cause:
(A) a reduction in the rate or amount of interest payable or the amount of scheduled interest accruals (including by way of redenomination);
(B) a reduction in the amount of principal or premium payable at redemption (including by way of redenomination);
(C) a postponement or other deferral of a date or dates for either (I) the payment or accrual of interest, or (II) the payment of principal or premium; or
(D) a change in the ranking in priority of payment of any Obligation, causing the Subordination of such Obligation to any other Obligation;
(ii) an expropriation, transfer or other event which mandatorily changes the beneficial holder of the Obligation;
(iii) a mandatory cancellation, conversion or exchange; or
(iv) any event which has an analogous effect to any of the events specified in Sections 4.8(a)(i) to (iii).”
[2] A “bail-in” is when a borrower’s creditors are forced to partially bear some of the burden of assistance through a write-off (in contrast, a “bail-out” is when a government or external investors rescue a borrower, whether by infusing cash or assisting in the servicing of debt). See What is a bail-in?, The Economist (April 7, 2013).
[3] See generally Letter of Minister of Finance Dijsselbloem to Parliament (English translation), dated February 1, 2013 (stating that “[i]t has been decided to expropriate the securities and other assets not only of SNS Bank but also SNS REAAL (the holding company). . . . the expropriation extends to both shares and subordinated creditors.”). After deferring a decision on two separate occasions, the relevant ISDA determinations committee ultimately decided by a vote of 14 to 1 that a Restructuring had occurred.
[4] “Governmental Authority” is defined in Section 4.9(b) of the 2014 CD Definitions to include the following:
“(i) any de facto or de jure government (or any agency, instrumentality, ministry or department thereof);
(ii) any court, tribunal, administrative or other governmental, inter-governmental or supranational body;
(iii) any authority or any other entity (public or private) either designated as a resolution authority or charged with the regulation or supervision of the financial markets (including a central bank) of the Reference entity or some or all of its obligations; or
(iv) any other authority which is analogous to any of the entities specified in Sections 4.9(b)(i) to (iii).
[5] See [DIR May 7, 2012].