(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)
By Neil Unmack
LONDON, Feb 12 (Reuters Breakingviews) - SNS Reaal’s SR.AS bondholders lost everything after the Dutch lender’s nationalisation, and the holders of credit default swaps may not get compensated. It's not the first time that CDS language has been found wanting.
SNS Reaal doesn't have many credit default swaps on its debt, but the Dutch government’s decision to expropriate bondholders could be a big issue for derivatives markets.
First, the expropriation may not trigger CDS, meaning investors wouldn’t get paid for the credit protection they bought. Credit default swaps are triggered by specific credit events; bankruptcy, failure to pay, or debt restructuring. Here, the bonds were simply confiscated. This problem could be circumvented. The committee at the International Swaps and Derivatives Association, which rules on credit events, may take a pragmatic rather than literal approach. Furthermore, an event may be declared later, when the government cancels the bonds.
There is a second issue. After a CDS event is triggered, the payout is determined through an auction of defaulted bonds, or when the buyer of protection hands the bond to the seller in exchange for the nominal amount of the contract. But in the SNS case, there are no bonds left in circulation. The payout could use SNS’s senior bonds - but these haven't been touched by the Dutch government and are trading above par, so it would not make sense for protection buyers to deliver them.
This looks bad for the CDS market, particularly the $3 trillion of swaps tied to bank debt. Paying for insurance you can’t use is not a great marketing ploy. The Dutch fiasco may not set much of a precedent; expropriation is rare, and a future pan-European resolution regime should clarify what happens when banks fail. Contracts could eventually be tailored to the new rules, although holders of old-style CDS will resist.
The SNS event highlights the balance that needs to be struck between determining the terms of CDS contracts as precisely as possible, and keeping them loose enough to cover unforeseen eventualities. That can be hard in sectors, like banks, where governments are prone to make up the rules as they go.
- The Dutch government on Feb. 1 nationalised banking group SNS Reaal, and expropriated the shareholders and subordinated bondholders of the group and its subsidiary, SNS Bank. The move will result in losses on 100 percent for subordinated creditors.
- A committee of the International Swaps and Derivatives Association has deferred a decision on whether the expropriation will trigger SNS credit default swaps, contracts used to hedge or speculate on corporate creditworthiness.
- Reuters: Dutch nationalise SNS Reaal bank group in $14 bln rescue [ID:nL5N0B11LP] - For previous columns by the author, Reuters customers can click on [UNMACK/]
(Editing by Pierre Briançon and David Evans)
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