Several years ago, the International Swaps and Derivatives Association, or ISDA, lost much of its credibility when during the peak of the Eurozone debt crisis, it first refused to determine that CDS on Greece had been triggered (i.e., that an event of default had taken place) only to eventually concede - following substantial outside pressure - that Greece had, in fact, defaulted (if only on bonds not held by a certain central bank), but not before penning a "petulant" blog post in which it claimed amusingly that the "credit event/DC process is fair, transparent and well-tested". The fiasco prompted many, this site included, to dub sovereign Credit Default Swaps as "Schrodinger's CDS", contracts which may or may not pay out in case of a default, depending on which way the political winds were blowing at any given time.
Fast forward to today when not only is ISDA in hot water again, but the entire corporate CDS market has been roiled by another indecision by ISDA, which said "it was unable to determine" if Singapore-listed Noble Group, formerly Asia's largest independent commodity trader was in default or not, creating a vacuum similar to what happened with Greece 5 years ago, and which, according to the FT, has resulted in mass confusion in the corporate bond and CDS market. What is more striking, however, is that this is "the first time ISDA has dismissed a question of default without making a ruling either way."
Specifically, on August 9, ISDA ruled the following:
The AEJ Determinations Committee (DC) has discussed over the course of a number of meetings the question as to whether a Restructuring Credit Event has occurred in respect of Noble Group Limited (Noble). 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).
Noble Group, of course, had for the past two years been one of the best advance indicators of stress in the Asian commodity markets, as noted here back in 2015. Since then the company's acute troubles intensified, leading to its repeat near-insolvency, profit collapse and accelerated asset liquidation meant to stave off an inevitable default. Last month, Bloomberg summarized Noble's woes best:
Noble Group has been in crisis for more than two years, marked by vast losses, mounting concern it will default and accusations it inflated the value of some contracts, which it’s denied. In an effort to raise funds, placate investors and pay down debt, the company has been selling businesses. With billions of dollars of borrowing outstanding, JPMorgan Chase & Co. said in a note that a coupon payment due July 29 on its 2020 bonds is now a key event to track.
The Noble salvage process culminated most recently with an extension to Noble’s loan repayment terms, an event which many CDS buyers, if not sellers and creditors, said amounted to a debt restructuring. And, as the FT adds, "the dispute rippled through debt markets in London and Asia last week after banks and funds served notice to sellers of CDS protection."
This is when the problem first emerged, because "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."
But since there is more than $1.2 billion of CDS written on Noble’s debt, it means that some of the biggest names on Wall Street would likely be involved.
They were indeed, and in a potential confrontation for the generations, the fate of Noble's default status has pitted some of the biggest names against each other.
According to the FT, on one hand we have Goldman Sachs, Nomura and hedge funds who bought CDS protection on Noble and would profit if ISDA determined that a CDS trigger event had taken place as they would then be paid off by the sellers of protection; these entities, however, are facing off against JPMorgan, BNP Paribas and other traders who sold the protection. As a result, more so than even the fate of Greek CDS, what happens to Noble, a pure-play corporate name, "is shaping up to be an important test for reforms made to the $10tn CDS market a decade after it was widely blamed for exacerbating the financial crisis."
Meanwhile, as ISDA unexpectedly decided to play coy, the market had already moved on with the first claim filed early last week, forcing a chain reaction of claims and counterclaims that spiralled through the market, with one source saying 12 institutions had triggered notices of default. The net total owed by sellers of CDS protection on Noble could be up to $157 million.
“Notices were flying all around the city,” said one hedge fund trader involved in the CDS market. “They wanted to be below the radar on this but the banks receiving the notices were obviously freaked out.”
The issue, however, is that without a formal determination by ISDA, Noble CDS remains untriggered and no payouts are actually due.
And while in the case of the Greece CDS trigger, ISDA was facing massive political pressure by the European political (and central bank) class, in the case of Noble the lobbying interests are more nuanced and all reside within Wall Street.
JPMorgan and BNP Paribas, which are said by traders in the CDS market to stand to lose in the event of a Noble default, have now filed questions with ISDA to move the process back in front of the industry body’s so-called determinations committee, which will meet on Tuesday. Goldman Sachs, Nomura, JPMorgan and BNP Paribas all declined to comment on their CDS positions. ISDA also declined to comment.
As a reminder, ISDA introduced the determinations committee system eight years ago in response to the chaos that credit derivatives caused in the financial crisis, after the mass triggering of protection linked to subprime mortgage bonds had to be settled between financial institutions bilaterally at the peak of the crisis. The most prominent example of cascading default triggers was of course the $85bn bailout of AIG by the US government after the insurer almost collapsed due to CDS exposure.
And so, until the ISDA D/C finds either way, "banks and funds that have bought or sold Noble CDS are essentially flying blind, with no precedent to follow, except how the market operated pre-2009."
“It’s like the whole last 10 years of market development have been put to one side,” said Nigel Dickinson, a derivatives lawyer at Norton Rose Fulbright.
“Because the ISDA determinations committee mechanism was supposed to avoid problems like this — market participants would ideally not need to trigger credit protection bilaterally.”
To be sure, there have been other ISDA controversies involving CDS trigger event: more recently, the collapse of Spain's Banco Popular sparked a dispute over the payout on CDS due to a dispute over legal claims against the bank. Then there is the whole issue of deeply rooted conflicts of interest:
The ISDA determinations committee has also faced criticism for being made up of representatives of the same banks and investors that stand to lose or benefit from their decisions.
There is a simple solution: ignore ISDA and let counterparties agree among themselves bilaterally whether there has been a default trigger event. Alas, that now appears impossible, even though the sum that would ultimately exchange hands is relatively modest. Furthermore, as the FT notes, "going back to the old system of bilateral settlements raises the prospect of more disputes and expensive court cases. Senior bank CDS traders say there is little appetite for a return and are looking for ISDA to make a call."
“The CDS market has made a lot of enhancements over the years,” said one person familiar with the business. “Moving to a determinations committee framework has definitely been a positive move.”
Except when ISDA itself is deadlocked and can't decide, of course.
In any case, the showdown between JPM on one side and Goldman on the other should be decided tomorrow, following repeat submissions of determination by both JPMorgan and BNP Paribas, both sellers of protection, which have pressed the ISDA DC to find whether...
a Credit Event Notice, delivered on or prior to 4pm London time on 23 August 2017, valid (and therefore will settlement obligations apply with respect thereto), if that Credit Event Notice indicates a Restructuring Credit Event on Noble Group Limited without the Unavailable Documentation, or without further relevant evidence (evidence unavailable to the DC) confirming the occurrence of a Restructuring Credit Event with respect to an Obligation of Noble Group Limited?
For the decision (hopefully) due tomorrow, which can be found here when it hits - which will inevitably displease either Goldman or JPMorgan - check back in 24 hours.