Credit event

A credit event ( English "Credit Event" ) describes especially in credit derivatives trading a particular event , a payment obligation by its entry guarantor is triggered. The term is also used in general in the credit system and describes the loss of life as a result of which a debtor can not meet the creditor's claims from the granting of credit . This triggers a loan termination by the creditor. The default clause used in lending and loan terms is largely the same as the credit event.

General

These clauses represent a sub-case of the doctrine of the discontinuation of the business basis , according to which the contracting parties do not assume any change in the external circumstances that are decisive for the execution of a contract . According to this, the validity of a contract is made dependent on the common ideas of both contracting parties about the future occurrence of certain circumstances when the contract was concluded (see Clausula rebus sic stantibus ). Since January 2002, the “disruption of the business basis” has been included in Section 313 (1) BGB , which occurs when serious circumstances arise after the conclusion of the contract that make it impossible for at least one contractual partner to adhere to the contract.

For insurance contracts which is damaging event precisely defined, so that the policyholder upon the occurrence of an event can decide whether an insured event (claim) is present and the agreed insurance benefit from the insurer must be provided. The covenants have a similar effect in banking , triggering a loan termination by the lender in the case of loans or the creditor in the case of bonds if a specific event, precisely defined in the loan agreement or the loan terms, occurs with the debtor or otherwise.

Legal issues

When formulating a credit event, a list that is as comprehensive as possible is important because, according to the enumeration principle, the occurrence of unlisted events may not trigger any payment obligations. Events that are not listed do not constitute a credit event if restrictive contractual wording such as “only” or “exclusively” are used. Then the payment obligation from the credit derivative / credit agreement depends directly on the occurrence of the credit event specifically mentioned in the contract. However, if extensive formulations such as “in particular” are used, an expansion of the events listed is conceivable by way of the interpretation of the contract . In the case of contracts under English or US law, a clear definition and independent verifiability of this event within the framework of case law is customary, because basically all conceivable facts must be mentioned. In the case of credit default swaps in particular , the definition of a credit event is of essential importance, since if it occurs, the protection seller has to make a compensation payment to the protection buyer for the specified reference asset / portfolio . Clear, non-interpretable definitions are therefore required in order to be able to determine whether a credit event has occurred or not.

These formulation principles can only be taken into account in contractual practice for loan agreements and loan terms. The Loan Market Association's contractual standards already include suggestions for covenants and credit events, which can, however, be modified. In the case of derivatives , on the other hand , the ISDA has specified uniform standard formulations that cannot be changed by the contracting parties and must be accepted.

Credit Events in Credit Derivatives Trading

The International Swaps and Derivatives Association (ISDA) defines the following 7 events as credit events in its framework agreements ( ISDA Master Agreements ).

• Insolvency and insolvency ( English "bankruptcy" ),
• early maturity of an obligation due to a circumstance that is not justified in the obligation itself ( English "obligation acceleration" ),
• Failure of a liability due to a circumstance that is not justified in the liability itself ( English "obligation default" ),
• Payment default ( English "failure to pay" ),
• Rejection of the obligation de jure or de facto ( English "repudiation "; see breach of contract ),
• Postponement of payment ( moratorium , English "moratorium" ) and
• Restructuring of the liability ( English "restructuring" ).

When entering into a credit derivative (e.g. a credit default swap ), some of these events are defined as requiring hedging . Practice are bankruptcy and failure to pay . If one or more specified events occur, the collateral provider's obligation to pay is triggered.

The ISDA Determinations Committee checks whether an event that has occurred or an existing fact can be subsumed under a contractually defined event by means of a majority decision (80%). The decision is binding for both contracting parties.

The members represented in the ISDA Determinations Committee can be subject to a conflict of interest if the financial institutions represented therein are themselves affected by the decisions of the committee.

Credit Events in Lending

In addition to the default-related credit events specified above, a deteriorating rating by a rating agency (rating-related credit event) can also occur. These credit events can be taken into account as covenants in credit agreements. So-called strike levels are upper or lower limits that are defined in the event of rating or spread changes. If at least one of the credit events occurs, this triggers a payment by the collateral provider or termination by the lender . The change of control clause in loan agreements or bond terms is intended to prevent a significant change of shareholder at the borrower that would change the basis of the business .

Debt rescheduling / restructuring of debtor Greece

Debt rescheduling (such as a simple consolidation of short-term into long-term debt) can already constitute a credit event if a corresponding agreement is included in the loan agreements or loan terms. This is all the more true for debt relief , because the associated “ haircut ” (percentage debt waiver by the creditors) violates the agreed credit terms. The fact of restructuring should also be included in a derivative contract as a credit event to take into account the risk-reducing effects of a credit derivative in accordance with Art. 216, 213 Capital Adequacy Ordinance (CRR).

During the Greek crisis in July 2011, the media raised the question of whether the debt relief (English haircut ) of 50% on Greek government bonds was already a credit event for credit default swaps (CDS) with Greek bonds as a reference asset . CDS on Greece belong to the so-called “Standard Western European Sovereign CDS” with which default risks on European countries can be hedged. For these, the credit event " Restructuring " is defined as the occurrence of one of the following events:

• the interest rate or the repayment amount is reduced,
• there is a delay in the interest or repayment of a bond,
• senior government bonds are issued to the detriment of the outstanding government bonds,
• the currency of the bonds will be changed to a non-G-7 or non- AAA rated currency.

The ISDA Determination Committee only deals with the decision on a credit event upon request. However, no application was submitted. Accordingly, no credit event was identified. Even submitting an application would not have been successful, as the Syndicus of the ISDA explained in an interview, since a voluntary debt exchange would not meet the conditions of a credit event. The opinion of the rating agencies , who classified the debt relief by credit institutions as a credit event, because the agencies are not themselves lenders and parties to the contract and their classification is not based on legal principles, is also irrelevant for determining the credit event in the sense of a CDS .

On March 10, 2012, the ISDA Determinations Committee decided to classify Greece's previous debt rescheduling campaign as a credit event despite a high voluntary participation rate. This is justified with the passing of a Greek law, which gives the Greek government the right to limit the rights of bondholders of Greek government bonds to receive payments from the bonds. The reason for the passage of the law was that only 83.5% - instead of the required 90% - of the private bondholders agreed to a haircut and therefore the statutory rescheduling clauses for this case come into force.

Individual evidence

1. ↑ ISDA: Credit Event definitions ( Memento of the original from February 16, 2012 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice. 
2. ↑ Axel Becker / Arno Kastner, Audit of the lending business by the internal audit department , 2007, p. 659
3. ↑ List of the applications of the ISDA Determination Committee ( Memento of the original from May 19, 2012 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice. 
4. ↑ Article and excerpt from a television interview by CNBC (English)
5. ↑ Tagesschau.de of July 22, 2011, Fitch evaluates the aid package as a payment default
6. ↑ Statement of the ISDA Determination Committee (English) (pdf; 179 kB) ( Memento of the original from March 23, 2012 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice.