Rakesh Saxena

Financial Company Default Risk

Good summary by Bespoke. But, Crocodilian, you have a valid point, which the regulators must clarify immediately before talking about a central clearing house. How "central" are these CDS contracts? What the variation levels in their contract terms? Many thanks - Rakesh


On Jan 10 07:33 PM Crocodilian wrote:

> Thanks for this. I've been interested in the precise terms of the
> CDS contracts-- and what precisely constitutes a default. We've had
> any number of complex transactions, and these companies often have
> a holding company/operating subsidiary structure.
>
> I've yet to see any discussion about the particulars of WaMu, for
> instance, were the operating subsidiary was purchased by JPM/Chase,
> but the holding company (and its debt) were left outstanding.
>
> In cases like these, or like Bear Stearns, I assume that the CDS
> is not triggered -- but that would depend on the specific language
> of these. In starting to read up on these intruments, there's a remarkable
> opacity and complexity to them, along with room for disagreement
> . . . "credit events" are determined by a "calculation agent", usually
> a third party.
>
> But grounds for disagreement and litigation are many, and there's
> no reason to believe that these instruments will speedily resolve.
> Here's a description of a recent litigation:
>
> "The court first examined whether a credit event had
> occurred. Citibank argued that a particular credit event applicable
> under the contract—an “Implied Write- down”—had occurred because
> the securities held by the Millstone CDO (which had issued the Class
> B notes) had decreased in value. VCG argued that the Implied Writedown
> provision only applied if there was a writedown in the Class B Notes
> themselves, regardless whether there was a decrease in the value
> of the securities in the Millstone CDO. After analyzing the CDS contract
> and the indenture for the Millstone CDO, the court concluded that
> the Implied Writedown provision referred to collateralized assets
> held by the CDO and not to the notes issued by the CDO. Accordingly,
> the court found that Citibank’s determination that a credit event
> had occurred in the form of an Implied Writedown was proper and that
> Citibank was entitled to judgment on the pleadings on that issue."
>
>
> (from "Manhattan Federal Court Enforces ‘Clear’ Terms of Credit Default
> Swap Contract on Pillsburylaw.com website)
>
> The point of all this is that not only are the amounts of outstanding
> CDS contracts huge, but their terms are not necessarily crystal clear
> . . . imagine if you had to litigate to effect settlement of your
> options trades!