The International Swaps & Derivatives Association ruled that a succession event has occurred for credit-default swaps insuring debt of Banco Espirito Santo SA.
The decision means that all contracts will be linked to a new bank, called Novo Banco, and won’t cover the lender’s outstanding subordinated bonds. The separation of junior swaps from the underlying debt, which remains at Banco Espirito Santo, is seen devaluing the contracts.
Banco Espirito Santo’s bonds were split as part of a 4.9 billion-euro ($6.6 billion) bailout by the Bank of Portugal, with the best assets moving to the new company and its most “problematic” assets left at the old entity. ISDA ruled this week that the bailout didn’t constitute a bankruptcy credit event that would have triggered payouts on default swaps.
There were 3,938 swaps covering a net $952 million of BES debt as of Aug. 1, according to the Depository Trust & Clearing Corp.
In a succession event such as a company dividing into two, the debt can remain whole with one entity or be split between each. If an entity takes on 75 percent or more of a company’s obligations that can be guaranteed by swaps, then the derivatives become linked solely to that entity, according to definitions published by ISDA. Otherwise, swaps are divided.
The credit derivatives market is being overhauled and new contracts offering better protection will start trading next month. The planned changes address flaws revealed during the financial crisis, with the list of credit events that trigger payouts being expanded to include bail-ins, when investors are forced to contribute to bank rescues, along with bankruptcy, failure-to-pay and restructuring.
Credit-default swaps on Banco Espirito Santo’s senior debt rose 15 basis points to 400 and junior contracts increased 26 basis points to 701, according to CMA prices at 12:20 p.m. in London.
The Lisbon-based bank’s 750 million euros of 7.125 percent subordinated bonds maturing November 2023 fell to 14 cents on the euro from about 100 at the start of the year, according to data compiled by Bloomberg.
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