Morgan Stanley says restructuring will not be required for capital relief

A subcommittee will recommend to the Basel Committee on Banking Supervision that capital relief from credit derivative hedging should not require the inclusion of restructuring as a credit event, Morgan Stanley analysts said in a report yesterday.

The US bank said that it understood that the recommendation would be made, but that “details are few.” Restructuring's inclusion as a credit event in default swap contract language is a highly contentious issue.

Some protection sellers, for example, claim that the Chinese walls between a bank’s trading and lending businesses aren’t necessarily airtight. They claim that debt capital markets desks may be inclined to make certain client business decisions - such as forcing a restructuring - on the basis that trading desk colleagues’ would then be able to realise in-the-money positions as default swaps are triggered.

Currently, banks typically defend themselves against such accusations by claiming that they only include restructuring as a credit event because of regulatory capital considerations. “If this change goes through, [protection] sellers will become more vocal about getting restructuring dropped completely,” said a New York-based credit derivatives structurer who spoke with RiskNews on condition of anonymity. “But the fact remains that many banks want it included for economic, rather than regulatory capital reasons,” he added.

A member of the credit derivatives research group at a US bank said that he would be “surprised” if Morgan Stanley’s claim about the Basel subcommittee’s recommendation was accurate. “In general, Basel doesn’t move this quickly. In the US, it’s not even clear if the Fed and the OCC would be on board with this change. It’s unlikely that Basel would want to be out of step with Washington,” he said.

Morgan Stanley’s North American credit research group made its claim regarding restructuring in a special report, published yesterday. The group declined to comment further.