Restructuring debate will rage on after CP3, says Munro

Speaking at the International Swaps and Derivatives Association’s 18th annual general meeting in Tokyo last week, Munro said many commercial banks would still push for restructuring to be included in credit derivatives contracts, regardless of the Basel Committee’s decision.

“It has been very easy for the commercial banks to hide behind the Basel II requirements to date that restructuring is a required credit event for offset,” said Munro. “My view is even if Basel II removes restructuring as a definite requirement for offset, that is not going to stop the debate that the commercial banks will want to have as to whether restructuring is a necessary credit event.”

The inclusion of restructuring as a credit event has been a highly controversial issue, with some investors claiming that lending desks of commercial banks could force a restructuring of a company on the basis that the bank’s trading desk – the protection buyers – could realise a profit on the credit derivatives contracts. Some commercial banks have in turn argued that restructuring has only been included within credit derivatives documentation to comply with regulatory capital requirements.

However, if the Basel Committee drops restructuring as a requirement for regulatory capital relief in its May consultation paper, this will merely push the debate in a new direction, said Munro.

“I actually think any change to remove restructuring in Basel II will be a positive development, because that would lead the debate to where it should be, which is with the market - the commercial banks and the end investors,” he said. “If restructuring is removed, it would potentially create large basis risk for the commercial banks.”

Meanwhile, Isda plans to examine the restructuring trigger in its credit derivatives documentation within the next few months, said Louise Marshall, New York-based policy director at the association.

“So far, we have concentrated on the deliverability of obligations in a credit event, but going forward we have undertaken at the behest of our investor members to examine whether a revision of the restructuring trigger itself is necessary,” she said.

Isda published its new credit derivatives definitions in February, which set out four restructuring options: no restructuring; full restructuring with no modification; modified restructuring; and modified-modified restructuring, a new provision aimed at addressing criticisms raised in the European market. The new definitions will come into effect from May 6, following a two-month delay caused by a longer than expected implementation of bank back-office systems, said Isda.