US loan market seeks to block CDS manipulation
NEW YORK, May 13 (LPC) – US companies try to prevent speculative investors from calling default events on leveraged loans to get payments under credit default swap (CDS) contracts at the expense of other lenders as investor activism intensifies.
Companies are trying to tighten loan documentation to prevent aggressive investors from pushing programs that profit their CDS holdings above the interests of borrowers or other lenders.
The move to add harsher new language to the documents follows two high-profile U.S. court cases involving home builder Hovnanian and telecommunications service provider Windstream.
The changes would limit the ability of CDS holders to call a default, either by removing their right to vote on creditors’ decisions or preventing them from holding a loan, sources say.
CDS effectively provides insurance for debt. Investors, who may hold a company’s loan, bond, or both, buy CDS contracts that provide protection against a negative credit event, including default or bankruptcy.
If the contract is triggered, the CDS seller will pay the buyer the difference between the par – 100 cents on the dollar – and the determined value of the debt.
The proposed consolidation loans modifications are designed to combat activist debt investors with CDS and “could prevent the activist investor from suing the company to accelerate debt primarily to favor its CDS position and not the debt it holds,” he said. declared Fabien Carruzzo, partner of the law firm. Kramer Levin.
While the aim of the proposals is to protect the US $ 1.2 billion leveraged loan market, the proposals are expected to meet some resistance from more aggressive investors.
Hovnanian and GSO Capital Partners of Blackstone Group were the first to receive legal action. Solus Alternative Asset Management filed a lawsuit last year after GSO helped organize a financing plan that would bar the builder from making its next interest payment.
This created a “ non-payment ” credit event that allowed CDS-protected buyers, including GSO, to receive payment for their contracts, according to a 2018 article from lawyers for Kramer Levin.
Solus and GSO agreed to settle the case in late May 2018 and Hovnanian made the interest payment it skipped on May 1, 2018, according to a press release.
Windstream filed for bankruptcy in February after a court ruled in favor of Aurelius Capital Management, which alleged that a 2015 split of the company’s telecommunications network assets violated its agreements with bondholders.
American companies are trying to end similar situations in the future. Prohibiting CDS holders from purchasing loans by adding them to disqualified lender lists is an option.
These lists usually consist of funds, institutional investors, and even competitors with whom borrowers prefer not to share private information or are prohibited for reasons such as prior activism.
“From a business perspective, they don’t want their lenders to commit to the loan with a schedule that doesn’t match their (plans),” said Jessica Reiss, Head of Commitment Research. loan from Covenant Review. “The company doesn’t want to feel like it can’t work with its lenders.”
Ideally, a disqualified list should be as narrow as possible to avoid impacting the ability of lenders to sell or exit their positions, Reiss said.
Another proposal for documentation would bar CDS owners from participating in lender votes, which would prevent them from calling a loan past due or executing it, sources said. This would not prevent a CDS holder who holds the obligation from calling a default bond.
This option would not affect liquidity as it does not restrict trading, but it relies on the honor system, which could require each lender to certify to the agent and the borrower before a vote that they do not. has no net short position, a source said. .
The US Commodity Futures Trading Commission (CFTC) has criticized the alleged manufacturing defects, saying they undermine the integrity of the CDS market.
“Market participants and their advisers are advised that in the event of artificial credit events, the (CFTC) will carefully consider all available measures to help ensure market integrity and to combat manipulation or fraud involving CDS, in coordination with our regulatory counterparts, where applicable, ”the regulator said in April 2018.
In March, the International Swaps and Derivatives Association (ISDA) announced that it was changing its definitions of CDS to cope with tightly matched credit events.
ISDA’s CDS proposal is a simple solution that requires credit deterioration at the underlying entity level for CDS to be triggered. This creates some uncertainty around the outcome, which is designed to deter a fabricated default strategy, Carruzzo said.
“If you only have a 50-50 chance that a strategy will work, that it will be considered a true credit event, you may be reluctant to do so because you are not sure you can monetize the contract,” a- he declared. (Reporting by Kristen Haunss. Editing by Tessa Walsh and Michelle Sierra)