Thursday, December 3, 2009

Aiful Debt Impasse Triggers ISDA Default Swap Review

Posted on Bloomberg by Shannon D. Harrington:

Disputes over credit-default swaps protecting investors in Aiful Corp.’s debt have spurred the association that sets global standards for the derivatives to review definitions governing the contracts.

The International Swaps and Derivatives Association is assessing whether Japan’s alternative dispute resolution process for companies restructuring their debt triggers a so-called credit event that would lead to payouts on swaps, according to Executive Vice-Chairman Robert Pickel.

“Situations arise where the terms of our contract need to be considered in light of a particular legal situation in a particular jurisdiction,” Pickel said in a telephone interview from New York yesterday. “We’ll certainly look at the ADR situation in this way.”

After Aiful entered alternative dispute resolution talks in September, a committee of 15 dealers and investors that determines when the swaps are triggered rejected three attempts to get payouts from contracts on the Kyoto-based consumer lender even as one bank said Aiful ceased making loan payments. Failure to reach prompt agreement may damage confidence in Japan’s market for the contracts, J. Paul Forrester, a partner and co- head of the derivatives and structured products practice at Chicago-based law firm Mayer Brown LLP, said in an interview last month.

Japan’s outstanding swap contracts jumped to $887.3 billion as of June 30 from $554.2 billion a year earlier, according to Bank of Japan data. Declaration of an Aiful credit event would lead to Japan’s first auction to settle the swaps, said Hisayoshi Nogawa, a strategist at BNP Paribas Securities Japan.

Higher Premiums

“If ISDA clarifies that going into ADR constitutes a credit event, that would make it much easier for credit-default swap buyers to trigger credit events,” Junichi Shimizu, a credit analyst at Deutsche Bank AG, said in a phone interview from Tokyo today. “Buyers will also be required to pay higher premiums in a transaction involving in a company which is distressed, or whose creditworthiness is getting worse.”

Credit-default swaps let buyers demand payment from sellers if the underlying company fails to make scheduled interest or principal payments, according to standard definitions published by ISDA. Banks, hedge funds, insurance companies and other investors use them to insure against default and to speculate on the creditworthiness of companies and countries.

Financial Catastrophe

Dealers and investors standardized credit swap contracts this year to make them easier to trade through clearinghouses, which act as buyers to sellers and sellers to buyers in a bid to prevent a single default from tripping a domino-like financial system catastrophe.

As part of that effort, ISDA formed regional committees in March to make binding decisions on when contracts are triggered. The committees base decisions on publicly available information such as regulatory filings, press releases and news articles. In most countries swaps are usually triggered by one of three events: bankruptcy, failure to pay or debt restructuring, including a reduction or postponement in principal or interest.

“We are closely watching the situation and what the decision will be” regarding a swaps ruling, Katsuyuki Komiya, general manager of Aiful’s public relations department, said in a telephone interview today. The company continues to make interest payments to all its lenders, he said.

Suspended Payments

Aiful temporarily suspended principal payments on its loans as part of the ADR talks, Standard & Poor’s said in a Sept. 24 statement, when it downgraded the company’s rating to “selective default.” Aiful had said Sept. 18 it would delay payments on some of its 915 billion yen ($10.4 billion) debt as it negotiates with creditors.

Aozora Bank Ltd. said in a statement submitted to ISDA that Aiful suspended scheduled payments of loan principal to all of its lenders on Sept. 30. The ISDA committee determining whether credit swaps are triggered then rejected two requests from Aozora in October to rule whether ADR talks constituted a debt restructuring or bankruptcy event that would allow protection buyers to demand payment, saying there wasn’t sufficient public information from which to make a judgment.

The committee, which includes Goldman Sachs Group Inc., JPMorgan Chase & Co. and Barclays Plc, was asked again by an unnamed firm on Oct. 15 to determine whether Aiful triggered the swaps by failing to make loan payments. The company making the request provided a list of loans with principal payments due from Sept. 24 to Sept. 30 that was intended as evidence, Deutsche Bank’s Shimizu wrote in an Oct. 20 report.

Public Proof

After initially accepting the request, the committee reversed itself when Aiful complained to ISDA that the document was confidential, people familiar with the matter said at the time. Without publicly disclosed proof that Aiful delayed payment, the panel rejected the request on Oct. 19, according to ISDA’s Web site.

The Japanese Association of Turnaround Professionals, which is mediating ADR talks with Aiful and Japan Airlines Corp., said last month that it was forming a group of bankers, lawyers and government officials to study whether the companies’ debt restructuring negotiations should trigger credit swap payouts.

The group’s findings “will inform” ISDA’s review “but is not binding,” Pickel said in the interview.

Contracts protecting a net $1.32 billion of Aiful’s debt were outstanding as of Nov. 27, according to New York-based Depository Trust & Clearing Corp. As much as $250 million more of Aiful’s debt is protected through swaps based on indexes in which the company is a member, Depository Trust data show.

“Market participants and overseas investors are paying full attention” to negotiations over Aiful swaps, BNP Paribas’s Nogawa said in a telephone interview today. “It’s positive to see that the association will make clearly stated rules on credit events and that this chaotic situation will be resolved.”

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