In a report published this week, Fitch analysts Roger Merritt, James Batterman and Tim Greening warn that the CDS market is not a perfect substitute for the loan and bond markets.In particular, in the event of a spin-off, loan and bondholders could find themselves benefiting from early retirement or protection agreements. CDSs, however, would not be retired early, even if the relevant obligations have been retired. It is not altogether clear what would happen in such a case, the report says, suggesting that the CDS holder could end up with a significant mark-to-market loss."The protection buyer could end up owning a short position with a shell company holding little or no debt and/or assets, whereas any actual hedged debt obligation no longer exists," the analysts wrote.They add that credit derivatives traders are now considering changing the standardised International Swaps and Derivatives Association documentation in order to protect CDS investors from the effects of a de-merger.
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