CDS Credit Events, Cross-Default, and Deliverable Obligations
Summary
The document addresses two credit default swap questions: whether a default involving debt other than the named reference obligation can trigger protection, and which debt may be delivered under physical settlement. It explains that a credit event on another obligation can trigger a cross-default affecting the reference obligation. If it does not, the CDS remains in force. It also notes that default on subordinated debt without default on senior unsecured debt is theoretically possible, though described as very unlikely.
Cash settlement is said to be more common than physical delivery. For physical settlement, the response says the protection buyer may deliver an obligation meeting the categories and characteristics specified in the contract, rather than necessarily delivering the exact reference bond. The example criteria include currency, governing law, issuance, and ranking; a lower-ranking subordinated bond would not qualify when the contract requires senior unsecured debt. The answer is a concise overview, and the contract’s specific terms govern the outcome.
Key ideas
- A credit event on another debt obligation can trigger cross-default on the CDS reference obligation.
- If the event does not trigger cross-default, the CDS remains in force.
- Cash settlement is described as more common than physical settlement.
- Physical delivery may use any obligation satisfying the contract’s specified categories and characteristics.
- A delivered obligation must meet the required ranking, so subordinated debt may not qualify for a senior unsecured reference.
Tags
Full text
# In a credit default swap, does the default event have to involve the reference obligation (ie a specific ISIN) # In a credit default swap, does the default event have to involve the reference obligation (ie a specific ISIN) If a company has a default in one of its bonds, but not the reference obligation referenced in the CDS, does that constitute a default? Also, if there is settlement via physical delivery, does the ref obligation have to be delivered or can another bond be delivered? Or is physical delivery not done anymore and its just cash settlement? ## Answer by Dimitri Vulis (score 1) https://quant.stackexchange.com/a/73368 1 It's quite common for the reference entity (company) to have a default or some other credit event on another debt, which in turn triggers a cross-default on the reference obligation. But if the event does not trigger a cross-default on the reference obligation, then the CDS lives on. Theoretically, one can default on subordinated debt and not default on senior unsecured, but it would be exremely unlikely (I can think of only one example). 2 Cash settlement is far more common than physical settlement. The term sheet should have the "Obligations:" section, and "Obligation Category:" is just "bond" or "bond or loan", and "Obligation Characteristics:", something like Not Domestic Currency Not Domestic Law Not Domestic Issuance Pari Passu Ranking If physical settlement is chosen, then the protection buyer can deliver to the protection seller anything that satisfies these criteria, i.e. pari passu with the reference obligation on the term sheet - can't deliver subordinated if the reference obligation is senior unsecured.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.