On Monday, June 24, 2019, U.S. Securities and Exchange Commission Chairman Jay Clayton, U.S. Commodity Futures Trading Commission (“CFTC”) Chairman J. Christopher Giancarlo, and U.K. Financial Conduct Authority Chief Executive Andrew Bailey issued a joint statement (“Joint Statement”) regarding collaboration to monitor the credit derivatives markets. The Joint Statement states, in part, that:
The continued pursuit of various opportunistic strategies in the credit derivatives markets, including but not limited to those that have been referred to as “manufactured credit events,” may adversely affect the integrity, confidence and reputation of the credit derivatives markets, as well as markets more generally. These opportunistic strategies raise various issues under securities, derivatives, conduct and antifraud laws, as well as public policy concerns.
The Joint Statement also notes that the agencies’ collaborative efforts would not preclude any of the agencies from taking independent actions under their respective authority.
The Joint Statement is the latest in regulatory statements focused on reversing perceived market trends in the credit derivatives markets. On April 24, 2018, the CFTC’s Divisions of Clearing and Risk, Market Oversight, and Swap Dealer and Intermediary Oversight issued a statement expressing concern regarding manufactured credit events, stating that “[m]anufactured credit events may constitute market manipulation and may severely damage the integrity of the CDS markets, including markets for CDS index products, and the financial industry’s use of CDS valuations to assess the health of CDS reference entities.” The CFTC Divisions committed to finding ways to “help ensure market integrity and combat manipulation or fraud involving CDS.”
The concept of a “manufactured credit event” arises in scenarios where an entity (“A”) intentionally defaults on one or more of its payments because the default triggers a credit event under a separate credit default swap (“CDS”) contract that benefits another entity (“B”). In these scenarios, A’s default creates minimal or no impact on itself or its general creditors in the cash market and the CDS Credit Event generates a payment for B.
In an effort to create a market solution to prevent manufactured credit events, on March 6, 2019 the International Swaps & Derivatives Association (“ISDA”) published proposed amendments to the 2014 ISDA Credit Derivatives Definitions (“Definitions”) relating such “narrowly tailored credit events.” Under the proposed ISDA amendments, the definition of the “Failure to Pay Credit Event” in the Definitions would require that the relevant payment failure result from or in a deterioration in creditworthiness or financial condition of the referenced entity in order to trigger a credit event.
Good day DR2.