CDS panel: Credit Suisse AT1 wipeout won’t prompt payout

More bad news for bondholders: but legal challenges to the write-off are set to continue. © Keystone / Peter Klaunzer

A panel tasked with overseeing the credit default swaps market said that the write-down of Credit Suisse Group AG’s Additional Tier 1 notes will not trigger an insurance payout. 

The Credit Derivatives Determinations Committee ruled at a meeting on Wednesday that the controversial wipeout of the high-risk bonds won’t lead to a payout of the default swaps tied to the bank’s subordinated debt, according to a notice on its website. 

In reaching its faster-than-expected decision, the committee took the view that the AT1 securities were in fact junior to the subordinated bonds underlying the swaps.

+ More on the legal challenges facing Switzerland after bond write-down

With Credit Suisse swaps tied to subordinated debt spiking in the aftermath of the UBS Group AG takeover, the trade looked like an exotic bet that could have unlocked huge gains.

The ruling puts the spotlight once again on an opaque panel representing the biggest dealers and traders across the CDS world, who also happen to be enforcers of the market rules. And it’s the latest twist in the Credit Suisse debt debacle that has stoked big market divisions. 

On one side, funds including FourSixThree Capital and Diameter Capital Partners have been buying the default protection linked to another set of junior Credit Suisse bonds, betting that the panel would rule in favour of a payout. On the other, market participants at Citigroup Inc, Barclays Plc and JPMorgan Chase & Co. had been telling their clients that the AT1s were likely to be deemed more junior than the subordinated notes linked to the default swaps – making a payout unlikely. 

No Credit Suisse involvement

The 11 members all voted in favour of dismissing the question as a trigger for the swaps. Credit Suisse, one of the members of the panel as of April 29, wasn’t part of the deliberations, according to the statement.

The price of default swaps tied to the bank’s junior debt rose this month before the panel was asked to consider the potential trigger, but have pared some of the gains this week. Given the hundreds of pages in supporting documents that accompanied the question, the speed that the committee issued a ruling took some market participants by surprise. 

The panel includes Bank of America Corp., Barclays Plc, BNP Paribas SA, Citigroup Inc., Deutsche Bank AG, Goldman Sachs Group Inc. and JPMorgan Chase & Co. Mizuho Securities Co. Ltd, Elliott, Citadel and Pacific Investment Management Company are also on the committee.

The underlying obligation referenced by the market participant, who submitted the question, was a sterling-denominated bond issued 23 years ago and matured in 2020. The panel ruled that the holders of these bonds were “priority creditors” versus the AT1 holders and as such the AT1 notes are “excluded obligations” in regards to the swaps.

Spokespeople for Bank of America, Citi, Elliott, JPMorgan, Goldman Sachs and Pimco declined to comment. Representatives for Barclays, BNP, Citadel, Credit Suisse, Deutsche Bank and Mizuho were not immediately available for comment. 

Highly technical

The questions typically brought to the panel relate to whether a specific event has occurred to an issuer’s debt that can trigger insurance payouts. Deliberations are often highly technical and can take weeks to resolve. The rulebook that the CDDC relies on, the so-called definitions by the International Swaps and Derivatives Association (ISDA), was last updated in 2014 and the panel has room for some discretion.

Last year, the panel found itself petitioning the US Treasury to help facilitate the settlement of insurance payouts tied to Russian sovereign debt. Meanwhile in 2021, protection buyers of Europcar Mobility Group who didn’t hold any of the company’s underlying debt were left with nothing, due to a shortage of bonds to settle contracts at the auction.

Total outstanding default swaps tied to Credit Suisse’s debt amounted to $19.6 billion of gross notional volume as of May 5, according to data from the Depository Trust & Clearing Corporation. The DTCC provides no split between the volume tied to the senior and the subordinated debt of the Swiss lender.  

The credit default swaps market was worth $9.7 trillion globally at the end of last year, according to data from the Bank for International Settlements. That’s an 84% drop in size versus the end of 2007. The market shrunk after regulators in the US and Europe introduced more steps to standardize and centralize the market as part of an effort to mitigate risks for participants. 

For example, watchdogs now require central clearing of some contracts, aimed at increasing pricing transparency.