Investors in some bonds issued by nationalized Dutch lender SNS Reaal (SR.AE) are seeking a firm answer today on whether contracts designed to compensate their losses will pay out, a closely watched case with wider implications for the banking industry.
An industry body delegated to decide the matter, the International Swaps & Derivatives Association Inc., meets again after ruling on Wednesday that protection against losses on bonds issued by SNS Reaal should pay out
But those payouts might be impossible to make, as bonds that are necessary to do this have been expropriated by the Dutch government. SNS Reaal was nationalized Feb. 1, wiping out the value of the bank's junior bonds.
If investors do not get their compensation, the rationale for buying protection would be weaker for other bonds, potentially deterring investment in subordinated categories of bank bonds and their derivatives across Europe.
"The future bank bail-in regime from the European Union, and political consensus around Europe, puts emphasis on hitting bank bondholders to spare taxpayers and depositors," said Michael Hampden-Turner, director of global macro strategy at Citigroup C +0.38% .
"More banks will be rescued in this way in Europe. Investors need to know if they can hedge their risk appropriately through credit default swaps," he said.
Bail-in regimes force creditors to take losses when banks are rescued, minimizing recourse to the kind of taxpayer-funded rescues that set off Europe's debt crisis.
Credit default swaps are widely used derivatives contracts acting as insurance for debt. If a borrower defaults, sellers compensate buyers.
SNS Reaal is not the first bank in Europe forcing losses on subordinated bondholders. All major Irish banks impaired subordinated bonds in their state bailout, alongside some U.K.-based lenders.
But it might be the first case in which bondholders who purchased credit default swaps to hedge against this possibility cannot claim compensation from those who sold them the contracts. To claim compensation, bondholders in SNS Reaal have to submit their securities to ISDA, which will run an auction. But as the government expropriated the securities, bondholders have nothing to deliver for the auction. In previous cases, bonds were left circulating.
They can submit senior bonds, but as these are not touched in the bank's rescue, they will not function to determine a significant payout.
One possible but unlikely way around this could involve asking the Dutch government to delay the expropriation date, enabling the auction to take place.
Another possible solution could involve the construction of a substitute contract representing a claim to the Dutch government.
It's a tough call either way--devising ad-hoc legal solutions for highly standardized contracts or asking the Dutch government to accommodate the needs of a few credit default swaps holders, whose securities outstanding are considered not relevant.
Derivatives Holders Await Clarity in SNS Reaal Case - WSJ.com
... ma i ciprioti non sono dello stesso avviso 
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