Basics of Credit Derivatives

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Credit Derivatives Cases, Court rulings. Litigation

This page is a comprehensive source of regulations on credit derivatives in various countries. If you have any contribution to make or a link to suggest, please do write back.

Also see

  • Our page on laws and regulations on credit derivatives here.


Ursa Minor Ltd. v. Aon Financial Products 2000 WL 1010278, at *6, 2000 U.S. Dist. LEXIS 10166, *19-*20 (S.D.N.Y. July 21, 2000)

This is one of the first rulings rendering certainty to a credit derivative contract. In this ruling, Ursa Minor (Bear Stearns) had bought protection from Aon Financial, against a loan to a Philippine entity. The loan in turn was protected by a guarantee from GSIS, a Philippine govt agency. On GSIS declining to enforce the guarantee, Ursa made a claim against Aon, whcih Aon declined on the ground that it has sold protection not against the default on the Philippino entity, and not against the withdrawal of the guarantee. The district court held that where the terms of the credit derivative contract are clear, it did not matter as to why the credit event happened.



Here Eternity, a hedge fund, argued against JPM that the latter had, by making misrepresentations and fraud, sold to it certain credit default swaps which turned sour and caused losses to Eternity. The CDS here was on Argentina as a sovereign - Eternity was a protection seller and JPM was the protection buyer.

One of the disputes in the litigation was whether the "voluntary debt exchange" program of Argentina, announced on 19 Nov 2001, was itself a credit event. The latter moratorium announced in Dec 2001 surely was a credit event, but there was a contention about the voluntary debt exchange being a credit event as well. On the contrary, JPM argued that the debt exchange was simply an "obligation exchange" under ISDA definitions which would have the effect of substituted the exchanged obligation for the original one.

There were also contentions by Eternity that Morgan had made representations about the liquidity of the CDS market which it actually failed to wind up the contracts as requested by Eternity.

On the first question of whether the definition of restructuring in ISDA definitions would include a voluntary debt exchange also, the key issue was whether the alleged restructuring was mandatory or not. It was contended by Eternity that if by economic coercion, the new debt was forced upon the holders, it was none-the-less mandatory. The district court held that the voluntary exchange was not restructuring, but the Appeal court reversed that determination and left it for determination of fact.

Eternity's claims on account of misrepresentation etc were dismissed.

The ruling is significant because it discusses at length the legal nature of a credit derivative contract too. Text of the ruling is here.


Aon Financial Products v. Societe Generale

This case is in a way related to the ruling in Ursa Minor discussed above. Here. Aon, which sold protection to Ursa, had in fact, bought protection from Societe Generale. In Aon/SG credit default swap, the reference entity was not GSIS but was the Govt of Philippines. When Aon had to make payment to Ursa (as per the ruling above), Aon claimed payment from Societe Generale, on the ground that the Aon/SG CDS was nothing but a reflection of the CDS between Aon/Ursa, and if there was a credit event on the latter contract, there was one on the former also.

ISDA had also interfered as amicus curae here and ISDA contended that the terms of the Aon/SG CDS were very clear and they referred to Philippine govt as the reference entity. It is a choice of a party of a trade whether it offsets a CDS by exactly matching terms, or creates an asset mismatch. In the present case, Aon had chosen to create a mismatch. There was a credit event with reference to GSIS, not with reference to the Govt of Philippines.

The Court held that SG was not liable under the CDS as there had been no credit event with reference to Philippines government. "There is, as noted, no reason to assume that the risk transferred to Aon was precisely the risk that it transferred or sought to transfer to SG". The definition of "reference entity" in the contract did not include ISDA's definition of "sovereign" - rather the parties referred to "Republic of Philippines". It is notable that the definition of "sovereign" under ISDA definitions is much broader -"any state, political subdivision or government, or any agency, instrumentality, ministry, department or other authority (including, without limiting the foregoing, the central bank) thereof".

The Court also went into the nitty-gritty of "credit event notice". As per ISDA definitions, the demand must be irrevocable. Aon's letter to SG was not irrevocable but was a conditional request - they talked about it they fail the litigation that they had filed regarding their obligation to pay to Ursa. The Letter did not event say that it was a notice of credit event.

Text of the ruling is here.



This ruling relates to whether "convertible bonds" of Railtrack, which went into administrative receivership, were actually "not contingent" in the ISDA's definitions of characteristics of a "deliberable obligation".

On analysis, the Court held that convertible bonds imply an option on the part of the debentureholder to convert, and therefore, they were "not contingent" securities.

The text of the ruling is here.


Deutsche Bank v. Ambac Credit Products No. 04 Civ. 5594 (DLC) (SDNY 6 Jul 2006).

This case highlights that simply buying protection on a CDS may not be enough - the credit event having occurred, one needs to meticulously comply with all deadlines in extremely precise manner.

Here, Deutsche Bank was the protection buyer and Ambac was the protection seller. The transaction related to a US company called Solutia that filed for bankruptcy on 13 Dec 2003. On Dec 17, DB had sent to Ambac a notice of publicly available information, and on Jan 16, (which is the last day on which the notice could be served as ISDA documetation provides for a 30-day window), DB sent to Ambac a notice of intended physical settlement.

It seems on 4th Feb 2004, Ambac instructed the depository to receive the physical delivery of Solutia securities. It also placed money with its bank to release on receipt of the securities.

DB was suppposed to receive the bonds itself from other CDS counterparties with whom it had sold protection. The facts noted in the case reveal that by the last date for delivery, that 11th Feb, there was no actual delivery done by DB. It was 4th March by the time DB had deliverable securities.

The ruling notes that the market practice is that the protection seller indeed expects to receive delivery by the delivery date. "There is a compelling economic reason for parties to expect that delivery deadlines in a CDS transaction will be inflexible. In such transactions, the protection seller agrees to take on a precisely defined level of risk, for which it is paid an amount determined by its underwriting calculations. An open-ended delivery deadline would make such fine-tuned calculations difficult. As a result, a protection seller is highly unlikely to provide this sort of coverage without an express discussion of its parameters and the associated additional premium".

Having established that DB failed in making timely delivery, the Court denied DB's claim to receive the protection payment.

Text of the ruling is here.