Not Subordinated: the test
Under the 2014 ISDA Credit Derivatives Definitions, an obligation has the Not Subordinated characteristic if it is not Subordinated to the Reference Obligation or, where one applies, the Prior Reference Obligation. The test is relative: it compares the bond’s ranking with the obligation that anchors the trade, not with an absolute idea of “senior debt”.
Subordination has a specific meaning. In paraphrase, one obligation is Subordinated to another when, by contract or trust arrangement, its holders are paid only after the other obligation’s holders in a liquidation or insolvency, or are not entitled to receive or retain payments of principal while the Reference Entity is in payment arrears or otherwise in default under the other obligation.
What does not count as Subordination
For corporate Reference Entities, two things are left out of the comparison:
- Preferred creditors arising by operation of law, such as statutory priorities in insolvency.
- Collateral, credit support and security. A secured bond is not senior to an unsecured one for this test, and an unsecured bond is not Subordinated to a secured one.
Because the definition turns on contractual or trust arrangements, structural subordination (holding-company debt behind creditors of operating subsidiaries) is not contractual Subordination either. It still matters commercially, and it can matter for which entity is the obligor, but it is not what this characteristic tests.
The Reference Obligation and the Prior Reference Obligation
The Reference Obligation is the obligation named for the trade; for many standard trades it is the Standard Reference Obligation published for the entity and seniority level. It sets the ranking benchmark: on a senior trade it is senior debt, on a subordinated trade it is subordinated debt.
A Reference Obligation can be redeemed or cease to apply. The Prior Reference Obligation keeps the test working when that happens. In broad terms, it is the Reference Obligation that most recently applied, or, if none ever did, any unsubordinated borrowed money obligation of the Reference Entity. A bond passes if it is not Subordinated to that benchmark.
Specified Currency
An obligation has the Specified Currency characteristic if it is payable in a currency the trade specifies. Where the trade specifies the Standard Specified Currencies, or none, the list is the lawful currencies of Canada, Japan, Switzerland, the United Kingdom and the United States, and the euro: CAD, JPY, CHF, GBP, USD and EUR.
The test is what the obligation is payable in. The deciding clause is usually the payment clause of the indenture or note form, which states the currency in which principal and interest are paid. A bond in a currency outside the list is excluded, however strong its other terms, unless the confirmation adds that currency.
How CDSBench tests them
- Not Subordinated. Mastermind checks how the obligation is described in its own terms: senior, senior secured, senior unsecured, unsubordinated or pari passu wording passes; wording that makes it subordinated fails. It does not yet compare the bond with the trade’s actual Reference Obligation, and it does not model structural subordination, so a subordinated trade needs that comparison made by hand.
- Specified Currency. Mastermind reads the currency from the documents and compares it with the Standard Specified Currencies.
For the other characteristics, see Maximum Maturity and Transferable.
In practice
Secured and unsecured notes, all in US dollars
Rite Aid’s 8.000% Senior Secured Notes due 2026 and New Fortress Energy’s 6.500% Senior Secured Notes due 2026 are both described as senior secured. Security is left out of the Subordination test, and nothing in either indenture ranks the notes behind other debt: both pass Not Subordinated. Dean Foods’ 6.500% Senior Notes due 2023 are senior notes, with the indenture providing that further notes rank pari passu with them.
All three indentures provide for payment in US dollars, which is a Standard Specified Currency, so all three pass Specified Currency.
Read the case: Rite Aid Corporation 2023 →Read the case: New Fortress Energy 2025 →Read the case: Dean Foods Company 2019 →
Common questions
- Does a senior unsecured bond fail Not Subordinated when the Reference Obligation is secured?
- No. For corporate Reference Entities, security, collateral, guarantees and other credit support are not taken into account when deciding whether one obligation is Subordinated to another, and neither are preferred creditors arising by operation of law. A senior unsecured bond is not Subordinated to a senior secured one for this purpose.
- Can a subordinated bond ever be deliverable?
- The test is relative to the Reference Obligation. On a senior trade, a subordinated bond ranks below the senior Reference Obligation and fails. On a subordinated trade, the Reference Obligation is itself subordinated, so a bond ranking equally with it is not Subordinated to it.
- Which currencies are Standard Specified Currencies?
- The lawful currencies of Canada, Japan, Switzerland, the United Kingdom and the United States, and the euro. A trade can specify other currencies; an obligation in a currency outside the specified list does not meet the characteristic.
This guide paraphrases CDSBench’s reading of the 2014 ISDA Credit Derivatives Definitions. The Definitions, the transaction’s confirmation and any Credit Derivatives Determinations Committee resolution govern. Decision support, not legal advice or a Credit Event determination.