Vue CDS triggered, but payout showtime still in doubt

Lack of public debt information raises more questions about credit event determinations

The reviews are in: it’s a credit event for Vue, the UK multiplex operator. After two months of debate, the industry group tasked with deciding whether such an event has occurred has answered in the affirmative.

The Credit Derivatives Determinations Committee – or DC – confirmed Vue’s recent debt restructuring constitutes a payment trigger on credit default swaps (CDSs) that reference its debt. The decision hinged on the ability to establish sufficient public availability of information regarding the debt – a condition for determining a credit event in a CDS contract.

Now CDS holders face a wait for their swaps to pay out, and a similar conundrum surrounds public availability of information. The private nature of Vue’s debt and restructuring documentation cloud this determination, in the same way it muddied the question of whether the CDS should trigger.

“[When the DC ruled,] they made a number of inferences that were very helpful for the market generally, because if that had not been a credit event, some people would have felt that they did not get the expected benefit,” says one CDS market participant. “Now the question is whether people can run an auction on the debt that’s outstanding.”

Now the question is whether people can run an auction on the debt that’s outstanding

CDS market participant

The situation highlights the pitfalls of trading contracts that reference non-public debt that is not relevant for swaps written on publicly traded, bond-issuing companies.

It’s uncertain whether debt restructured by the company is eligible for delivery either by bilateral settlement or in a default auction – the DC’s preferred method for determining a contract’s payout.

For the week ending March 10, the gross notional in contracts outstanding on Vue was more than $720 million, according to the Depository Trust & Clearing Corporation. This is roughly half the gross notional outstanding for the same week last year. In the same one-year period, the net notional outstanding fell by $7 million to $61 million.

The DC, which comprises 13 voting members from both bank and buy-side firms, has been debating the question of Vue’s restructuring since early February, when an anonymous participant posed the first of three Vue-related questions put to the group. Since then, the committee met over a dozen times before publishing a decision on March 22.

“They can get second-guessed either way, so it’s a tough position to be in,” says George Cahill, partner at law firm Alston & Bird, speaking before the committee’s decision. “They’re expected to make quick decisions, often on limited information, so that the market can work efficiently.”

Trigger – happy?

Under the rules governing credit derivatives contracts, a corporate restructuring can trigger CDS payouts if a company’s deteriorating creditworthiness or financial condition forces it to make changes to its debt obligations. The trigger typically affects European corporates, but not those in North America, where a company is more likely to restructure after filing for bankruptcy, which would itself trigger a bankruptcy credit event.

Vue announced in a January 26 press release that it had completed a recapitalisation in which roughly £470 million ($579 million) of debt was removed from the company’s balance sheet. Meanwhile, first-lien lenders swapped their debt for control of the company and the maturity of existing debt was extended.

Vue’s actions stemmed from the financial challenges it has faced since the outbreak of Covid, which kept moviegoers away from cinemas. The financial deterioration condition for triggering a credit event was never in question. Instead, the DC faced an issue of public disclosure.

Committee decisions must be based on publicly available information – and in cases like Vue’s, where a private company restructures private debt obligations, the group has less information on which to base its decision – unless documents appear through a legal procedure, or a company releases them.

In its March 22 statement, the committee acknowledged the challenge this requirement posed, noting that it “had extensive discussions considering whether to dismiss the DC Questions”. But the group ultimately agreed that the information submitted with the questions – coupled with the January press release and documents from both the UK’s Companies House and Jersey registries – provided enough public information to satisfy the condition.

It’s always been a running debate of whether the DC should be empowered to make discretionary, subjective determinations

David Hong, Kirkland & Ellis

Only the DC’s Citi representative disagreed that the documents provided enough information for a determination, voting “no” on the question of whether a restructuring credit event had occurred – and making the vote a rare non-unanimous decision for the committee.

In 2017, a similar case saw the committee dismiss the question of whether Noble Group’s extension of its loan repayment constituted a restructuring credit event, ruling that there was not sufficient public information.

“This is a risk the CDS market faces when dealing with capital structures that do not have publicly available documents,” says Cahill.

“Parties certainly need to be aware of that risk when they buy CDS on a company that currently has private debt documents. But even a company with publicly available debt documents can refinance with private documents during the life of a CDS trade.”

Show me the money facility

The committee now faces similar disclosure questions surrounding Vue’s outstanding debt and whether it qualifies for CDS settlement. The group has asked market participants to alert it to “public copies of the new money facility, the reinstated facility and the amended intercreditor agreement”.

If there are no qualifying obligations for CDS holders to deliver bilaterally or for market participants to deliver into an auction, contracts will fail to pay out. The committee could also rule that it cannot determine whether the outstanding loans qualify for an auction and leave it to counterparties to settle bilaterally.

How settlement takes place will also depend on the outcome of a further Vue-related question put to the DC, in which a market participant requested that it consider Vue’s transaction as a bankruptcy credit event.

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While settlement under a restructuring credit event limits participants to debt obligations roughly matching the maturity of their swap contracts, settlement for a bankruptcy event does not, and allows contract holders to deliver any qualifying obligation. Multiple auctions can take place to settle a restructuring event, but after a bankruptcy, only one auction occurs.

The March 8 bankruptcy question points to Section 4.2(c) of the 2014 Credit Derivatives Definitions, published by the International Swaps and Derivatives Association, which states that a bankruptcy credit event occurs when the company in question “makes a general assignment, arrangement, scheme or composition with or for the benefit of its creditors generally, or such a general assignment, arrangement, scheme or composition becomes effective”.

The claim relies on the argument that the announced restructuring amounts to a transfer of the company’s assets to first-lien lenders.

David Hong, partner at law firm Kirkland & Ellis, says the committee would have to “stretch a bit” to call a conversion of debt to equity a general assignment and to class the transaction as a bankruptcy credit event and says that this goes to the question of the committee’s role.

“It’s always been a running debate of whether the DC should be empowered to make discretionary, subjective determinations. Is [it] supposed to be a literal governing body, looking at the contracts literally? Or [is it] supposed to be more of a subjective body that’s allowed to make discretionary decisions?”

The DC’s leeway to make such decisions has expanded in recent years with the addition of the narrowly tailored credit event protocol – the industry’s attempt to stamp out manufactured defaults benefiting CDS holders.

“The market wouldn’t have tolerated that amount of subjective discretion back when the DC was first instituted,” says Hong.

This one could run and run.