Wall Street's Shady Practice of Triggering Bond Defaults Draws Scrutiny From Regulators
Wall Street's Shady Practice of Triggering Bond Defaults Draws Scrutiny From Regulators
(Bloomberg) -- Financial regulators in the U.S. and U.K. said they will work together in combating “opportunistic strategies” in credit derivatives markets including so-called manufactured defaults that have triggered a series of high-profile legal fights.
The heads of the Securities and Exchange Commission, Commodity Futures Trading Commission and U.K. Financial Conduct Authority released a joint statement on Monday citing the potential of such strategies to harm the integrity, confidence and reputation of the markets.
The SEC’s Jay Clayton, CFTC’s J. Christopher Giancarlo and FCA’s Andrew Bailey vowed to “prioritize the exploration of avenues, including industry input which will address these concerns and foster transparency, accountability, integrity, good conduct and investor protection.” The collaborative work won’t preclude the agencies from acting on their own, the regulators said.
Powerful investment firms in recent years have been accused of earning big money from swaps trades by enticing companies to miss bond payments they could otherwise make.
ISDA Proposal
Concerns over such transactions prompted the industry’s main trade group to also take action earlier this year. In March, the International Swaps and Derivatives Association aimed to ensure that defaults would be tied to legitimate financial stress, rather than traders’ derivatives bets.
“These opportunistic strategies raise various issues under securities, derivatives, conduct and anti-fraud laws, as well as public policy concerns,” Clayton, Giancarlo and Bailey said in their statement.
The regulators’ agreement follows a series of cases that have stoked controversy in an $8 trillion corner of the global derivatives market.
One trade that was widely seen as a tipping point occurred last year when Blackstone Group LP’s GSO Capital Partners encouraged homebuilder Hovnanian Enterprises Inc. to skip an interest payment in return for a sweetheart loan.
Other defaults that have led to outrage include transactions involving broadcaster iHeartMedia Inc., paper maker Norske Skog AS and Spanish gaming company Codere SA. In a more recent example, hedge funds fought over whether notes issued by Sears Holdings Corp. could be used to engineer the size of the payout from CDS contracts.
Giancarlo, who is set to leave the CFTC next month, has repeatedly expressed concern over the trades. In April 2018, his agency said that “manufactured credit events may constitute market manipulation and may severely damage the integrity of the CDS markets.”
--With assistance from Davide Scigliuzzo.
To contact the reporter on this story: Ben Bain in Washington at bbain2@bloomberg.net
To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net, Gregory Mott
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