As the BES and the New Bank exchanged turns to international banks
The decision of the Bank of Portugal to recapitalize the New Bank created controversy in the markets. The largest banks and international managers are divided on how to assess the measures taken by Carlos Costa.
January 22, 2016 • Business
By Rui Barroso – Business Journal
The decisions taken by the Bank of Portugal for the resolution of BES are raising questions about the functioning of a market segment not known but who has a large size and complexity:. the credit derivatives
existing value of such contracts that are traded outside the regulated market, is around 14 billion dollars. During and after the financial crisis these instruments were widely criticized. And the authorities tried to squeeze the mesh to trading of these instruments. However, this kind of “inner circle”, as he called it to Bloomberg, are the participants themselves who define the rules. This view is contradicted by the International Swaps and Derivatives Association (ISDA).
When participants in this market have doubts about whether instruments as “credit default swaps” can be activated pose questions to the ISDA.
ISDA names then a Decision Committee to give an answer to these questions, which determines where will millions or billions of euros placed in derivatives given entity. But cases of BES and Banco created new difficulties to how they decide these disputes one of the most complex areas of financial markets.
DECODER What are CDS? The “credit-default swaps” are financial instruments that function as a sort of insurance in case of default on the obligations of an issuer. If there is a credit event, the holders can offset some or all of the losses in obligations of the entity concerned. Can be used as protection but also to speculate a higher credit risk or default of bond issuers. They are sold by investment banks and other financial institutions, by paying an annual premium. If there is credit event banks that sold the CDS profit. Already there is non-compliance incur losses.
The impact of European rules
The tasks of the ISDA decision to committees may seem simple on paper. Must vote in the event of losses in bonds, the factor that led to the losses constituted or not a “credit event” (if there was non-compliance). When the answer is “yes”, the CDS are activated and who holds can be reimbursed or, in the case of speculative investors, fit capital gains. Another of the most common decisions after insolvency or restructuring, is deciding what the entity to which CDS are applicable (sequence of event).
But the rules changed for European banks, which were reflected in the way the Bank Portugal dealt with the resolution of the BES, led to it being difficult to have consensus in the association committees. How one defines a “credit event” even had to be changed to be more comprehensive and include decisions similar to those taken by the Bank of Portugal.
Governor of the Bank Portugal, Carlos Costa, announced the measure of resolution to BES in August 2014. The resolution of August 2014
The first clash between the decisions taken by the Bank of Portugal and the rules on derivatives markets occurred in August 2014. On the 3rd of this month the governor of the Bank of Portugal, Carlos Costa, announced that it had been “deliberate a measure of resolution” to the BES. The senior debt holders have become creditors of the New Bank. Who already held subordinated debt, which is the first to be called to suffer losses, became the lender’s “bad bank”
The very next day after Carlos Costa ad ISDA received two questions:. If there was an “Event credit “and the CDS would continue to serve as BES debt insurance or would become for the New Bank.
few days later, the Committee to answer these questions we decided that as the majority of the liabilities started BES to the New Bank CDS would then focus on the bridge bank. And understand that there was a “credit event”.
CDS which were useless in BES
Committee constituted by the ISDA up took little time to answer the questions when Resolution BES, in August 2014. But the decision left the CDS holders of subordinated debt BES without the right to any compensation.
The problem was that, under the rules then, if the CDS on subordinated debt were activated, it would be necessary to activate the provisions of “cross default”, causing the CDS on senior debt were also executed.
Given the European legislative changes to banking, these rules have been updated. The terms “cross default” were removed in the event of a “credit event” motivated by state intervention, a new category defined by ISDA. If the resolution of BES in 2014 occurred some time after the CDS could be activated on subordinated debt and leave intact these instruments on senior debt.
Uncertainty in CDS 350 million New Bank
Over time, the Bank of Portugal was adjusting assets and liabilities that would be the bridge bank and bad bank. The December 28 2015, the organization led by Carlos Costa decided to transfer five series of senior obligations of Novo Banco to BES, completing the measure of resolution.
The decision caught them unawares markets. And he revealed difficulty in consensus within the Decision Committee of ISDA. On 30 December the association came the question of whether the decision of the Bank of Portugal constituted a credit event motivated by state intervention.
There is no unanimity in the answer to the question. Four entities perceived that he had been a “credit event”, other 11 voted against. Some of the financial giants harmed by decisions of the Bank of Portugal BES resolution process, such as Goldman Sachs and Pimco had the right to vote in the Committee. But the lack of consensus led to the decision to be taken now by external evaluators. After the CDS will be on the New Bank or BES?
and doubts do not stop here. On January 5, it was put another question: if the passage of five series of bonds for BES would lead to a succession event. For that to happen, the Committee has to consider the percentage of relevant obligations considered passing to a new entidade.Mas also this decision was postponed as the Committee considered that does not have sufficient and updated information to be able to deliberate on this issue. The classification of central bank lending to the New Bank will have a crucial role to decide whether the CDS carried over in full or in part for BES. However, the Committee reported that the information had not been confirmed by either the New Bank nor the Bank of Portugal.
After repeated postponements, the decision on credit derivatives Novo Banco is scheduled for until February 12 . Only after that answer be known what happens to the net value of 380 million dollars (350 million euros) of the entity’s CDS led by Stock da Cunha.
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