Financial Regulatory Forum

Thomson SA to test new Europe CDS settlement rules

August 14, 2009
CDS | eu | france

thomson-logo   By Natalie Harrison
   LONDON, Aug 13 (Reuters) – A credit event at France’s Thomson SA, the first to feature in a current benchmark European credit default swap index, will test the market’s ability to cope with complex new auction rules to settle CDS.
   The first hiccup came on Thursday as dealers switched to a new index that excluded Thomson CDS from the mostly “junk”-rated Crossover index <ITEXO5Y=GF>, which was the major contributor to a sudden 30 basis points jump tighter.
   The next hurdle is likely to be a challenging auction process, credit strategists at Citigroup said in a note. “The timing is bad too, with a new protocol just released and a market under closer scrutiny than it has ever been,” they said.
   The European derivatives market introduced the “Small Bang” process last month for settling payments under CDS contracts after restructuring credit events. [ID:nLF217404]
   A credit derivatives committee on Wednesday decided a waiver from Thomson’s creditors in June to defer a $72.5 million principal payment on a 6.05 percent senior note due in 2009 was a restructuring credit event.
   “This is the first restructuring event globally and the first real test of the ‘Small Bang’ protocol,” said Tobias Sproehnle, director of indices at Markit, which owns the iTraxx indexes.
   Up until now all global credit events have been either bankruptcies or were due to a “failure to pay”, meaning the indexes have usually been traded with the defaulted credit until after the auction process, Sproehnle said.
   In the case of a restructuring event, however, “Small Bang” rules require the credit to be spun off from the index immediately because of the optionality of the protection buyer or seller to trigger the CDS contract.
   “If that procedure would not be followed the market could be left with thousands of index versions in case of multiple restructurings, which would be very difficult to handle especially when it comes to clearing,” said Sproehnle.
   Holders of the new version of the 44-name index excluding Thomson also have in addition a single-name CDS on Thomson, which they decide whether to trigger or not in the auction.
   
   SHORT SQUEEZE
   Citigroup strategists Peter Goves and Michael Hampden-Turner said the auction process would probably result in high recovery rates on Thomson bonds, which means buyers of protection would receive a lower payment than might usually be expected.
   There is likely to be a shortage of bonds that can be delivered to settle CDS, given that most of the company’s bonds appear to have been privately placed, Citi said.
   That shortage, combined with a high volume of outstanding CDS, will likely push recovery rates closer to par values, Citi added.
   Net notional exposure to Thomson in the CDS market is nearly $2 billion, according to data from the Depository Trust & Clearing Corp (DTCC).
   There has already been a short squeeze on Thomson’s most liquid June 2012 revolver, with the price jumping to 70 percent of face value from 40 percent, Citi said.
   Thomson also was a constituent of seven former series of the investment-grade iTraxx Europe index, making it a relatively common credit in collateralised debt obligations (CDOs) that were put together between 2003 and 2007.
   The bulk of the bonds included in these structures are due to mature within the next three years and many are not deliverable, meaning there will be limited ratings impact on these investment-grade synthetic CDOs, Citigroup said.
   Fitch Ratings said Thomson is directly referenced in 77 synthetic CDO transactions, or 28 percent of Fitch-rated synthetic CDOs. The agency said it expected minimal impact on CDO ratings. [ID:nWNA1259] (Editing by David Holmes) ((natalie.harrison@reuters.com; +44 207 542 2687; Reuters Messaging: natalie.harrison.reuters.com@reuters.net))
 Keywords: THOMSON/CDS
  
Thursday, 13 August 2009 16:46:40RTRS [nLD624770 ] {C}ENDS

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