(Bloomberg) -- Canyon Partners head Josh Friedman said GSO Capital Partners went “beyond the bounds” of how deals should be done when it required a homebuilder to default on debt in order to gain new financing.
The default could allow GSO to collect on side-bets that it had used to wager against Hovnanian’s debt, a series of a arrangements that were “a little unseemly," Friedman, Canyon’s chief executive officer, said during a Bloomberg TV interview with Erik Schatzker at the Milken Institute Global Conference. The side-trades were done using credit default swaps, a derivatives market that was designed in part to compensate investors if a company ended up unable to pay its obligations.
When a fund’s efforts go against the intent of the credit derivatives market, “it calls into question your ability to use those instruments,” Friedman said.
Concerns about the market’s integrity also came from David Solomon, who is tipped to be the next chief executive officer of Goldman Sachs Group Inc. He said at the same conference that better guidelines are needed, with more clarity and definitions so participants understand the structure of the market and the way contracts are supposed to work. Goldman is on the losing side of the GSO trade, having sold credit derivatives that would be triggered by the homebuilder defaulting, and is among the firms that has cried foul.
Markets for credit-default swaps were roiled after GSO, Blackstone Group LP’s credit arm, loaned money to Hovnanian Enterprises Inc., which in turn agreed to default on a portion of its debt. The failure would trigger payouts on $333 million of CDS contracts that GSO had bought, allowing the money manager to collect on its bets.
The Commodity Futures Trading Commission said last week it may act to prevent manufactured CDS payouts to help “ensure market integrity and combat manipulation or fraud,” without singling out GSO and Hovnanian by name. Goldman’s Solomon said he agrees with the statement, and that it’s important for the market and participants to "have integrity."
When asked whether regulators should intervene in the trade, Canyon’s Friedman said that it was time for the CFTC to "shut that one down." He was speaking at the Milken conference in Beverly Hills, California on Monday.
A representative for Blackstone didn’t immediately respond to a request for comment. Hovnanian said it hasn’t participated in the credit default swap market, it acted properly at all times, and is always guided by its duties and obligations to shareholders.
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