Comments on: How the CDS market makes restructurings more difficult http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: crack http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-605 Mon, 20 Apr 2009 14:48:13 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-605 Ginger, so how are equity for debt swaps handled by a CDS? If I insure bonds to $10 and a restructuring happens that changes their value to $2 and a bunch of equity do I get paid the $8 difference irrespective of the theoretical value of my equity? Or is the equity valued at some level?

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By: Ginger Yellow http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-600 Mon, 20 Apr 2009 12:14:09 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-600 Restructuring is a credit event (not an event of default, but something that triggers the CDS) in all standardised corporate CDS: “Restructuring covers events as a result of which the terms, as agreed by the reference entity or governmental authority and the holders of the relevant obligation, governing the relevant obligation have become less favourable to the holders that they would otherwise have been. These events include a reduction in the principal amount or interest payable under the obligation, a postponement of payment, a change in ranking in priority of payment or any other composition of payment. A default threshold amount can be specified.”

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By: Jacob http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-586 Sun, 19 Apr 2009 23:28:04 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-586 I think both you and Hemant have the math slightly off in your example.

You bought $600,000 in CDS protection, which you get in the event of a default. Also, you hold a $1 million bond, and you “will end up collecting no more than 20 cents on the dollar in a liquidation.” So you’ll get an additional up to $200,000 on the bond. That puts you at between $600,000 and $800,000, so I guess we’re all right?

There’s no “$400,000 unhedged portion” of the bond; the CDS contract is orthogonal to the bond itself

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By: Aiden http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-583 Sun, 19 Apr 2009 20:59:44 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-583 If you believed that the out of court restructuring would happen and would increase the price of the bonds you would close out the CDS. That way, you make money on the CDS and on the bonds that you originally bought. This happens a lot with put options on equities. You buy the put as protection against a position you have on and when you think that the bottom is in you sell the put.

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By: Tom Cole http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-578 Sun, 19 Apr 2009 18:36:26 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-578 It is my humble opinion that capitalistic systems only work when the owner bears the direct risk of his/her investments. This provides a powerful incentive to invest wisely, and hence allocate capital to productive uses. It also provides a powerful incentive for the owner to be actively involved, demanding that management make the occassional tough choices necessary to keep the business sound.

Bonds that are insured create direct owners that do not bear appropriate risk of loss. Index mutual funds create direct owners (the management company) that do not bear the risk of loss. Throughout our entire financial system, we have found cleaver ways to divert risk from the direct owner in the name of ‘risk management’.

Show me a capitalistic system in which the direct owners do not bear the risk of loss, and I will show you a capitalistic system that cannot properly allocate capital, and is destined to failure.

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By: dWj http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-574 Sun, 19 Apr 2009 02:36:05 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-574 Ideally, bankruptcy rules would be such that there would never be a reason to restructure outside of bankruptcy; bankruptcy exists for the purpose of restructuring. How close we can come to an ideal system is an open question. We could certainly come closer.

This is reminiscent, though, of a situation a couple years back where a hedge fund holding a bunch of debt bought a bunch of the company’s stock while selling it all forward so that they could vote the shares in favor of an issue that benefited bondholders. In principle you could argue that it’s the responsibility of the buyer of the forward to monitor and/or charge for this, and in practice if this were quite common, I imagine its possibility would get priced into the forwards and/or some steps would be taken to ameliorate it. CDS sellers might be expected to tend toward the same behavior. How long that would take in practice, how far it would go, and what collateral damage it would do to the markets of the derivatives and the underlying cash securities are probably harder to guess and unlikely to exactly line up with market efficiency.

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By: Don the libertarian Democrat http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-573 Sun, 19 Apr 2009 02:03:25 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-573 Let me try and understand this: I own a bond of a particular company that I bought expecting to be paid a certain amount. To protect my investment, I accept the extra investment of insurance on that bond. I thereby lessen my risk, and increase my expenses. Another bond buyer doesn’t buy insurance and has more risk. What on earth is wrong with that? It makes perfect sense to me.

So, the company is trying to restructure outside of bankruptcy. Let’s leave the type and point of bankruptcy out of it in this case. I can either accept a deal from the company or hold out for bankruptcy, depending upon what is better for me. Isn’t that our system?

The company can induce me to accept their restructuring plan by convincing me that they have a plan that will pay off for me in the long run, etc. If they don’t have one, I shouldn’t have to accept their plan.

As near as I can tell, we’re trying to create a system where my taking less risk is to be penalized because it might not fit some other person’s view of whether or not a particular company is worth trying to save. Weird. Another day, another weird and paradoxical proposal. I surely must be misunderstanding this argument. I must be very tired. I apologize.

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By: OneEyedMan http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-572 Sun, 19 Apr 2009 01:11:33 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-572 I wrote that no bearer bonds had been issued in 20 years. I guess I don’t really know that, there may be a few that slip through the current legal net. But if they are still around they are a small part of the market. Most bonds are not anonymous.

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By: OneEyedMan http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-571 Sun, 19 Apr 2009 01:09:54 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-571 “The whole point of issuing bonds is that they’re tradable, fungible, and anonymously held.”

There is no anonymity in bond holdings. Anonymous bonds are called bearer bonds (as in pay to the bearer). From a combination of legal rules, there haven’t been barer bonds issued in over 20 years. Most securities these days are registered in some form or another (often to the broker), my understanding is that’s how they send you the coupon or dividend.

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By: Hemant http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/comment-page-1/#comment-570 Sun, 19 Apr 2009 00:08:21 +0000 http://blogs.reuters.com/felix-salmon/2009/04/18/how-the-cds-market-makes-restructurings-more-difficult/#comment-570 Not sure if this is right, though doesnt change the argument ; “if I agree to the company’s plan. If I just let it go bust, on the other hand, I get $600,000.”
If I let it go bust, I will get 25 cents on 1 mio notional from the company (250K) + 75 cents on 600K notional from CDS seller (450K), for a total of 700K.

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