Fully Clothed CDS

Lots of questions about the Blackstone CDS trade that Bloomberg wrote a great piece on back in October, and that Jon Stewart has now brought (finally) out into the light.

In short, Blackstone buys CDS on a company's bond debt while giving the same company a new senior loan facility.  One provision of the loan facility is that the company promises to pay its bonds after the grace period – which constitutes a technical "failure to pay" under the ISDA credit definitions.

A few quick thoughts:

First, while the trade undoubtedly is valid by its strict contractual terms, I would not assume that it could not be challenged. Namely, if ever there was an opportunity to invoke the old implied covenant of good faith and fair dealing, it might be here. Normally the covenant is a last resort argument in finance transactions, but maybe, just maybe ...

Second, however, this is a relatively small trade and Blackstone's counterparties probably value Blackstone's overall business too much to litigate this one. But do future trades with Blackstone get priced with an eye to this trade? That is, will Blackstone pay in the long term?

And this is, of course, the very sort of manipulation that Skeel, Partnoy and your's truly predicted years ago.

Comments

[Ray Collier]

The logical solution would be for the sellers of the CDS at issue to petition the International Swaps & Derivatives Association to reverse its ruling that there was a failure-to-pay credit event.

That is, there may have been a (deliberate) two-day failure to pay but it certainly was not a credit event.

One would think that ISDA would sua sponte be simultaneously taking any available punitive or expulsion actions against Blackstone. Blackstone's conduct threatens the entire CDS market.

From my perspective that - the beginning of the end of the CDS market - is the silver lining to all of this.

[Knute Rife]

I agree with Ray. If ISDA lets a CDS holder create the default terms, that giant sucking sound will be investor money fleeing the CDS market.