CDS market: Beware the net short debt activist
Isda needs to take action over manufactured defaults.
When Blackstone’s GSO Group came up with a debt restructuring plan for New Jersey-based building firm Hovnanian earlier this year, the debt exchange was dependent on manufacturing a cheapest-to-deliver security that would produce a bumper pay-out on the firm’s CDS from a default that was also part of the plan.
The scheme drew harsh criticism and was seen as an outrage – a threat to the integrity of the CDS market itself.
Although GSO is a master of the art, such behaviour – dubbed “net short debt activism” – is far from isolated. It involves building up a long position in the debt of a company in order to assert a default that will trigger CDS pay-outs from a larger short position. Still smarting from the bad publicity surrounding the Hovnanian default, the CDS market is now braced for further reputational damage from another such situation.
Hedge fund Aurelius, which has a long history of debt activism, has been fighting a lengthy battle in the US with rural internet services provider Windstream, alleging that a sale leaseback of its fibreoptic cable network in 2015 violated debt terms in place to preserve assets for noteholders.