CDS market passes Altice debt test
The US$9trn credit default swap market passed its latest test on Wednesday after an auction to settle CDS on Altice France determined protection holders would receive enough compensation to cover expected losses on bonds belonging to the beleaguered telecoms giant.
The final Altice CDS auction price was set at 87.75, meaning that CDS holders would receive US$12.25 for every US$100 of protection they owned. That result was roughly in line with where bank traders had quoted Altice debt prices earlier in the day.
The Credit Derivatives Determinations Committee, a panel of banks and investors that rule on CDS market matters, had overseen painstaking preparations for Wednesday’s auction amid widespread concerns that a so-called lock-up agreement in Altice’s mammoth €24.1bn debt restructuring could torpedo proceedings.
Those fears were ultimately allayed thanks to strong demand to buy Altice's bonds in the second round of the auction – a dynamic that ensured pay outs to CDS holders broadly matched market expectations.
Relief
The result will come as a relief to proponents of these controversial derivatives. It took the CDS committee more than two months and 22 meetings to arrange what would ordinarily be a routine affair to settle the contracts after Altice announced its restructuring in May that will lower its outstanding debt by €8.6bn to €15.5bn.
The problem hinged on a lockup agreement in the restructuring that the committee said covered 95% of Altice's bonds. That clause threatened to restrict the amount of Altice’s bonds that could be used in the auction, which in turn risked skewing results and potentially short-changing CDS protection buyers.
CDS auctions are designed to establish a fair market price for a company’s debt – and therefore the size of the pay out needed on CDS contracts to compensate for losses that investors face on their bond holdings. Any restrictions on the debt available for delivery into an auction therefore risk producing unexpected results that don’t reflect economic reality.
In the end, the committee decided to include a mechanism in the Altice auction designed to address the bond scarcity issue for CDS holders that wanted to settle their contracts physically. Physical settlement involves delivering, or taking delivery, of a company’s bonds. The measure, known as the “composite package”, involved the use of assets that Altice bondholders will receive from the company’s forthcoming debt exchange for its restructuring, which closes on September 9.
There were a net €38m of requests to sell Altice bonds in the auction to settle CDS contracts physically. These requests are filled by limit orders placed through dealing banks in the second round of the CDS auction. The price at which the orders are filled becomes the final auction price.
In this case, all of the €38m of net sell orders were filled at the highest limit order price of 87.75, which was placed via Goldman Sachs. Bank traders had earlier indicated that Altice’s bonds were on average worth a price of 86.25.
The result suggests that there was strong demand for the Altice bonds despite the lockup agreement. However, it is not clear from the auction results whether the composite package of assets from Altice’s forthcoming debt exchange will be used to meet any of the requests for physical CDS settlement. Altice’s restructuring is scheduled to take effect from October 1, meaning any CDS trades involving the composite package won’t settle until after that time.
High profile test
The complications over Altice’s debt lockup had made Wednesday’s auction the latest in a series of high-profile tests for the CDS market, as quirks around the CDS auction process have repeatedly threatened to undermine the value of the contracts as a hedge.
Last September, just one security worth US$22m of principal was used to settle the US$888m outstanding of Avon CDS. In 2021, CDS contracts on car rental company Europcar proved worthless after banks participating in the auction could not source €7.4m worth of the firm’s bonds.
Such events have coloured investors’ views of the instrument. The Altice saga may do little to alleviate those concerns among sceptics despite the auction delivering what appears to be a fair outcome for CDS holders.
“The [Altice] restructuring does appear to be complicating the CDS auction process. When something that complex and noisy happens, we tend not to get involved,” said one high-yield investor speaking prior to the auction.
“If you look at [the] 15-year trend … this issue has come up repeatedly. [Such issues] do put people off and as a consequence single name CDS volumes are lower.”
Additional reporting by Jane Li