What counts as a credit event? Bankruptcy vs Failure to Pay

The credit events in the 2014 Definitions

The 2014 ISDA Credit Derivatives Definitions define seven credit events: Bankruptcy, Failure to Pay, Obligation Acceleration, Obligation Default, Repudiation/Moratorium, Restructuring and Governmental Intervention. A trade applies only those its terms elect, usually by reference to the transaction type in the ISDA Physical Settlement Matrix. Standard North American corporate trades elect Bankruptcy and Failure to Pay, without Restructuring; European and other regional contracts can add Restructuring, and Governmental Intervention applies mainly to financial Reference Entities.

Three questions stay separate throughout: what happened, whether the contract recognises it as a credit event, and which obligations can then be delivered.

Bankruptcy

In paraphrase, the Bankruptcy Credit Event covers a Reference Entity that:

• is dissolved, other than through a consolidation, amalgamation or merger;
• is insolvent or unable to pay its debts, or fails or admits, in writing in a judicial, regulatory or administrative proceeding or filing, its general inability to pay its debts as they fall due (a press release alone is not such an admission);
• makes a general assignment, arrangement or composition with or for its creditors;
• institutes, or has instituted against it, insolvency or bankruptcy proceedings, or a petition for its winding-up or liquidation (for proceedings or petitions brought by others, subject to the 30-day rule below);
• passes a resolution for its winding-up or liquidation, other than on a merger;
• seeks or becomes subject to the appointment of an administrator, receiver, trustee or similar official for all or substantially all of its assets, or has a secured party take possession of all or substantially all of its assets; or
• causes or suffers an event with analogous effect under the laws of any jurisdiction.

A voluntary Chapter 11 petition by the Reference Entity falls within the proceedings limb: the entity itself has instituted them.

The 30-day rule for petitions by others

Proceedings or petitions instituted by the Reference Entity itself, or by its primary insolvency, rehabilitative or regulatory supervisor in its home jurisdiction, count at once. Proceedings or petitions brought by anyone else, such as a creditor’s winding-up petition, are treated differently. They count only if they lead to a judgment of insolvency or bankruptcy, an order for relief or a winding-up order, or if they are not dismissed, discharged, stayed or restrained within 30 calendar days of being instituted or presented. A similar 30-day window applies where a secured party takes possession of the entity’s assets.

That is why a creditor’s winding-up petition, reported for example in a UK Gazette notice, is not yet a credit event: such petitions are often paid off or dismissed. What matters is the order or the 30 days, counted from presentation of the petition, which is earlier than the Gazette date.

Failure to Pay

Failure to Pay occurs when, after any applicable Grace Period has expired, the Reference Entity fails to make payments when and where due under one or more of its Obligations, in an aggregate amount at least equal to the Payment Requirement. Four elements do the work:

• Obligations. On standard corporate trades the Obligation Category is Borrowed Money, so a missed payment on a loan counts as much as one on a bond.
• Grace Period. The grace period in the obligation’s own terms applies. The 2014 Definitions deem a minimum grace period of three Grace Period Business Days where an obligation has none or a shorter one. Where Grace Period Extension applies, a Potential Failure to Pay on or before the trade’s scheduled termination date can still become a Failure to Pay when its grace period (by default capped at 30 calendar days) ends after that date.
• Payment Requirement. The minimum unpaid amount, by default USD 1,000,000 or its equivalent unless the trade specifies otherwise.
• Potential Failure to Pay. A missed payment still inside its grace period is a Potential Failure to Pay, not yet a credit event.

Who decides: Determinations Committees

For trades that incorporate the Definitions, questions such as whether a credit event occurred, and on what date, are put to the relevant regional Credit Derivatives Determinations Committee. Its resolution governs those trades, and when it resolves that a credit event occurred it also decides whether an auction is held and settles the Final List of Deliverable Obligations. The date the question was submitted is recorded, because the Definitions measure some timing from it.

A filing, a news report or an issuer statement is evidence, not a determination. Read any resolution on the Determinations Committees’ site with the documents behind it. For what can be delivered after the event, see What is a Deliverable Obligation?