One hundred and one pains in the SNS for the CDS market [update] | FT Alphaville

One hundred and one pains in the SNS for the CDS market [update]

The nationalisation of the fourth largest bank in the Netherlands is proving to be a pain for the credit derivatives market. It’s only by virtue of the small number of contracts outstanding that referenced SNS Bank that this hasn’t been making more headlines and causing more consternation.

The Isda Determinations Committee has already declared that the expropriation of the subordinated debt of the bank was a restructuring credit event, and that there might be some auctions to determine payouts under the swaps. But it looks like that result of the auctions could prove a bit farcical, with buyers of protection walking away with very little compensation for the total loss experienced by subordinated debt holders.

There are only 101 credit default swaps that referenced SNS Bank in existence. Some of these reference subordinated bonds which the government expropriated when it nationalised SNS Reaal, the bank’s parent company. Herein lies the difficulty. Payouts on the swaps, from the protection seller to buyer, are usually determined by auctions in which all of the big dealers trade bonds relevant to the CDS in question. So for the auctions to work well, some trading of the sub bonds would need to occur. But there are no sub bonds unless the Dutch government releases them. See the problem?

Which brings us to some remarkable hopeful chappy or chappete who has submitted their hopes and dreams to the Isda committee’s secretary by asking that a sub bond be appended to the initial list of bonds that could be considered for use in the auctions.

** Bonds 48 and 49 are Supplemental Obligations which have been submitted to the DC Secretary following publication of the Initial List and these obligations have not been considered by the Determinations Committee.

*** Bond 49 is included to the extent that such Bonds are released by the State of the Netherlands.

That’s just cute! Like, look at those footnotes. Aww. As if the Dutch government would think, ‘oh, ok, we just used even more taxpayer money to support one of our banks and burned over a billion euros that belonged to investors… hey guys I have a great idea, let’s help out traders in credit default swaps by releasing some of the bonds so that they can have their auctions!’

The final list of bonds should be published soon, given that the deadline for submitting challenges to the initial list passed on Monday at 5pm. From there, the buyers and sellers of the 101 CDS can then decide whether or not to trigger their contracts (they don’t have to and the ultimate payout can differ in some cases depending on whether the buyer or seller pulls the trigger).

Triggering phase over, the Isda committee will meet again to decide whether to actually hold auctions. Auctions because the senior and sub CDS in theory need separate ones — though probably not in this case because there are no subordinated bonds to deliver — and different maturity buckets are usually required when the type of credit event is a restructuring, as SNS Bank was deemed to be.

The end result being that if auctions are held, the payout for the subordinated CDS will end up being very small as it will reflect senior bond “recovery”. That is, the senior bonds will be used in the subordinated bond auction(s). Or rather, the subordinated CDS holders will end up taking part in the senior CDS auctions, if they even occur.

While the market goes through the motions, changes are afoot in the CDS market with new definitions in the pipeline for this year, as participants seek to adapt it to the ever-changing bond market, e.g. to bank bail-ins, funky sovereign debt shenanigans and so forth. But more on that another time.

For now, we’re stuck rubber-necking at the SNS Bank auction process. Shame on us…

Update 11:40 London time: The final list has been published. Fingers on triggers!

Related links:
CDS Contracts Not Ready For The Ways We Go Bankrupt Now – Dealbreaker
SNS Reaal could test CDS changes – IFR