j. andrew rahl, jr., moderator mark c. ellenberg peter niculescu alexey surkov november 28, 2011...
TRANSCRIPT
J. Andrew Rahl, Jr., ModeratorMark C. EllenbergPeter NiculescuAlexey Surkov
November 28, 2011
DISTRESSED INVESTING 2011
TRADING AND VALUING DISTRESSED DERIVATIVES
TOPICS
Introduction
CDS on Sovereign Debt: Will it Pay?
The Lehman Valuation Framework
Enforceability of Noteholder Payment Priority on Default: the “Flip Clause”
MF Global Update
Introduction
What is a derivative?
a financial instrument derived
from an underlying asset (reference asset)
Key Concepts
Swaps
Valuation
Posting of Collateral
ISDA Documentation
US Bankruptcy Safe Harbor
Introduction – Credit Default Swaps
Credit default swaps (CDS) are derivatives which pay on default = credit insurance
Reference obligation is the underlying debt
Per ISDA documentation: the insurance only pays on a triggering event, such as a credit default
If the CDS is triggered, the protection buyer gets cash and delivers (swaps) the underlying debt to its swap counterparty
Sovereign CDS
Outstanding Sovereign CDS (Net Notional in USD 11/18/11)
France $24.1B
Italy 21.2
Germany 19.5
Brazil 17.6
Spain 16.9
Greece 3.4
Sovereign CDS Documentation Q: What are the ISDA terms for a sovereign CDS?
A: “You will need to look at several documents together for that answer (it is not in a single document per se).
Will also vary by sovereign.
Good 1st start is to go to the “ ISDA Credit Derivatives Physical Settlement Matrix and Confirmation (Most Recent Version October 2011)". You will get an excel spreadsheet - click on the tab marked "Sovereigns" and there you will see the ISDA standard terms for various sovereign issuers. To make sense of those terms, you will need to look at the 2003 ISDA Credit Derivatives Definitions, as modified over the past 8 years or so through various supplements and protocols.
Wish I could tell you it was easier . . .”Source: 11/23/11 email from Andrew Cross of RS
Sovereign CDS
A Credit (Triggering) Event includes:
Failure to pay
Repudiation/Moratorium
Restructuring: includes haircut, payment deferral,
subordination, change in currency must occur in a form that binds all holders of
the ‘restructured debt’
Sovereign CDS
Per ISDA (10/27/11 Update):
Credit Events are determined by a regional ISDA determination committee (DC)
The question will be submitted to the Euro DC when ripe; it will weigh the publicly available evidence and vote on whether a Credit Event has occurred
All firms entering into ISDA CDS transactions have agreed to be bound by the determination
Lehman Valuation Framework
A comprehensive solution for all counterparties: “rough justice”
Contrary to the ISDA, the defaulting counterparty set the parameters
Reluctance to admit that bid-ask is part of the claim
No supporting data provided for the framework
One size for all counterparties no matter how big or small
Lehman Valuation Framework
Swap spreads by maturity and currency
Volatility spreads for options
Credit spreads for CDS
Liquidity spreads for large size positions
Spreads for complexity
Tables of “Add on” spreads for each major category of instrument, e.g.:
The Flip Clause Dante CDO (structured by Lehman) sold CDO notes to
investors (noteholders) for cash; the notes were rated AAA
The CDO held the cash in trust as collateral for the CDO notes but entered into a credit default swap with Lehman which provided for various payments off the top to Lehman
If the swap terminated due to Lehman’s default, the CDO notes became due and the cash in the trust would repay the notes and thereby cut off payments to Lehman This “waterfall flip” was to take effect if the swap termination
was caused by Lehman’s default
If the swap terminated for other reasons, there was to be a substantial up-front payment to Lehman that would materially impair the CDS notes
The Flip Clause
The documents were governed by UK law
The noteholders sought to terminate their swap before Lehman filed in the US and be paid the cash collateral underlying the swap based on the waterfall flip; UK courts agreed and upheld enforcement of the flip
Lehman asked US Bankruptcy Court to invalidate waterfall flip, ignore UK ruling, and direct BNY to distribute substantial cash to Lehman
The Flip Clause
Bankruptcy Court invalidated subordination of Lehman’s swap claim against the Dante CDO:
held: a waterfall “flip” is not enforceable when it is triggered by the bankruptcy filing of either the swap counterparty or its credit support provider void as an ipso facto clause
ipso facto applied retroactively to bankruptcy filing of swap counterparty or related entity
US bankruptcy law governed the matter despite UK choice of law clause in documents
Flip Clause – Why should You Care?
Can’t rely on waterfall flip even if it is in your contract
Bankruptcy Court can retroactively determine that automatic stay and ipso facto prohibitions apply before the Ch 11 filing of your counterparty – as long as a related entity filed before termination
Where swaps are part of a complex transaction, a Bankruptcy Court may review and interpret a swap independently from related transaction documents
MF Global Update
2011
In the wee hours of Monday October 31, 2011 MF
Global filed its bankruptcy case in SDNY – and $1.2B of customer money is missing?
$ $ $
MF Global Update
Parties:
Louis Freeh, Bankruptcy Trustee
James Giddens, SIPC Trustee
CFTC
Written Materials
Greek Sovereign Debt Q&A page 1 - ISDA Update 10/27/11 (excerpts)
Derivatives Claims Settlement Frameworkpage 5 - May 27, 2011 Legacy Asset Management Co,
Letters to the Lehman Court re Settlement Framework, SDNY Bk Case # 08-13555
page 49 - JP Morgan, October 4, 2011, D.I. 20580
page 52 - Citibank NA, October 4, 2011, D.I. 20570
Written Materials
Bankruptcy Court “Flip Clause” Decision page 54 - SDNY Bk Case No. 09-02142 D.I. 86
District Court Decision Granting Appealpage 79 - SDNY Bk Case No. 09-02142 D.I. 117