September 19, 2021

Schrödinger's CDS

Noble Group currently occupies a state that is neither defaulted nor non-defaulted.
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For all the talk about credit default swaps being perilously complex and troublesome, they're really pretty simple instruments. They work on the assumption that a given company at all times occupies one of two states: (a) normal, and (b) defaulted. When (a), the CDS buyer pays the CDS seller. When (b), vice versa. There are Pokemon cards with more complicated terms than this.

isda-question-mark

But what if there were some indeterminate stage between (a) and (b), between defaulted and non-defaulted? What if the International Swaps and Derivatives Association, which governs CDS and makes those default determinations, decided to go quantum-mechanical in its deliberative approach? Thanks to the ongoing self-immolation of commodities trader Noble Group, we'll soon find out:

Earlier this month the ISDA committee responsible for deciding on the status of Noble’s debt said it was unable to determine if the Singapore-listed commodity trader was in default or not, creating a vacuum that allowed bilateral claims to proliferate across the market. It is the first time ISDA has dismissed a question of default without making a ruling either way.

This is made awkward by the fact that banks and traders have some $1.2 billion in outstanding bets on Noble Group's debt. Battle lines have already formed:

Goldman Sachs, Nomura and hedge funds who stand to gain from having bought CDS protection on Noble are facing off against JPMorgan, BNP Paribas and other traders. [...] After the first claim was filed early last week, it forced a chain reaction of claims and counterclaims that spiralled through the market, with one source saying 12 institutions had triggered notices of default.

Why the dispute? A couple months ago Noble restructured its debts in an apparent effort to masochistically prolong its own suffering. Though this wasn't a default, credit default swaps don't require a default to trigger the “default” in the name “credit default swap.” Instead, CDS contracts can be invoked with so-called credit events ranging from ordinary bankruptcy to restructuring. The latter, according to the ISDA's latest definitions, includes “a postponement or other deferral of a date or dates for either the payment or accrual of interest or the payment of principal or premium.”

But somehow the ISDA committee that classifies credit events can't make a decision on whether Noble postponing a loan payment qualifies as Noble postponing a loan payment. From the ISDA Credit Determinations Committee, which was formed after 2008 in order to facilitate smoother CDS resolutions:

The AEJ DC considers that it currently does not have sufficient information that is public or that can be made public to determine the Restructuring Credit Event DC Question one way or the other, in particular the AEJ DC has not been able to obtain the underlying documentation in respect of the Borrowing Base Facility (and amendments thereto) and Noble’s guarantee in respect thereof (the Relevant Documentation).

This probably isn't what you, a seasoned CDS investor with hundreds of millions in outstanding CDS bets, want to hear. If anyone should have the relevant documentation related to whether a company has defaulted or not, it should probably be the international consortium devoted to determining whether companies are defaulted.

For clues as to why there's some gridlock amidst the committee, which has kept Goldman and Nomura at loggerheads with JPMorgan and BNP Paribas, maybe we should have a look at who it is that makes up the committee:

Bank of America N.A.
Barclays Bank plc
BNP Paribas
Citibank, N.A.
Credit Suisse International
Deutsche Bank AG
Goldman Sachs International
JPMorgan Chase Bank, N.A.
Mizuho Securities Co., Ltd.
Societe Generale

Are we suggesting that certain members of the vaunted International Swaps and Derivatives Association Credit Derivatives Asia Except Japan Determination Committee are letting conflicts of interest interfere with their contractual obligations? Until the committee has a more believable explanation for its gridlock than “the dog ate my Noble Group borrowing facility documentation,” then yes, yes we are.

World’s biggest banks square off over Noble credit default swaps [FT]

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