
Goldman Traders Are Caught Up in a Bizarre, Tense Hedge Fund Battle - techolic
https://www.bloomberg.com/news/articles/2017-12-07/goldman-traders-caught-up-in-bizarre-tense-hedge-fund-battle
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chollida1
Surprised that HN likes this article:)

I'll start by laying out my biases and stating that I'm not a big fan of most
PE firms.

I think most people understand that CDS are a few things.

1) usually bespoke in that each one is different, ie these are contracts that
you approach a bank to write for you and not fungible like a share. This means
they are generally illiquid and usually don't pay out.

2) These used to be used, and still are, as insurance for bond holders.

3) as everyone how as seen or read the Big Short now knows, they started to be
used by third parties to speculate on bankruptcies.

4) They pay out only when the agreed upon terms are triggered

Blackstone, the PE firm holding the CDS's, is trying to get an otherwise
healthy firm to "default" on some of their debt so that Blackstone can get the
CDS payout.

The problem is that the firm doesn't need to default so Blackstone is enticing
them with better funding rates for their debt if they just do a "tiny bit of
defaulting".

Like I said, I don't really have alot of respect for PE firms.

This is dirty. If this is allowed to happen then who in their right mind would
ever again underwrite a CDS for a companies debt if some other company can so
easily force a default event.

I know that 2008 probably soured the term CDS for the average person but they
are a very important part of the credit market and risk management.

Just to be clear, the companies bonds are trading at or above par value,
indicating that investors have confidence in the company’s ability to satisfy
its debts as they come due.

~~~
tome
I've always been so puzzled by these "synthetic" financial products. If
someone wants to "insure" a corporate bond, why don't they just swap it with a
bank for a cash flow stream guaranteed by the bank, minus some premium?

~~~
yellowstuff
Uniformity is a major advantage of CDSs. Bonds are idiosyncratic- every one
will has its own maturity date, coupon payments, and lots of minor details in
the bond covenants. That makes bonds hard to trade. CDS are far more uniform-
they trade with standard terms and maturities. Bonds are primarily a way to
provide companies with funding, CDS are primarily an instrument for financial
companies to trade.

Could a company "insure" a bond by writing a swap with a bank? Sure, a bank
would be happy to write a bespoke swap with you, but they're going to charge
more than a CDS would cost, and you're not going to be able to trade the swap
to someone else.

CDS actually make it easier for companies to raise money. If you can hedge
your weird, illiquid bond with a nice liquid CDS you're more likely to buy the
bond in the first place.

FWIW I'm not a specialist in fixed income, so don't take this as gospel, but I
think the general point is right.

~~~
whatok
Not sure I necessarily agree with the point about making it easier for
companies to raise money. I agree with it at face value but not based on what
usually happens in the market. Chances are, if there's liquid CDS for an
issuer, they're not going to be issuing weird, illiquid bonds. On the other
side, if all an issuer has are weird, illiquid bonds outstanding and without
knowing anything about the issuer, I would say it is negative to have a liquid
CDS market as that's probably a negative creditworthy signal.

I'm sure some academic has done a study about how CDS has shaved a few bps off
borrowing costs for large IG issuers though.

Agree with everything else in there.

~~~
yellowstuff
Thanks for the info!

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totalZero
> Blackstone came along with what it pitched as a better deal, but with an
> unusual provision: Hovnanian had to agree to do it in a way that would
> trigger credit-default swaps, which are essentially side bets on whether the
> builder meets all of its debt obligations. That would lead to quick gains
> for GSO because it had been buying short-dated insurance contracts.

If this is true, it should be illegal (and probably is). CDS is a derivative,
and derivative traders are generally not permitted to manipulate the
underliers of their products. It would be like buying stock on a particular
expiry date to push a much larger, cash-settled digital option into the money.
Expect a flurry of legal action if things go according to plan for GSO.

~~~
whatok
Not going to comment on the legality of this but this isn't the first time BX
has done this and nothing happened previously. See [0]. I actually don't
necessarily have a problem with this as the underlying company theoretically
should see a real benefit from this.

[0]
[https://www.bloomberg.com/view/articles/2013-12-05/blackston...](https://www.bloomberg.com/view/articles/2013-12-05/blackstone-
made-money-on-credit-default-swaps-with-this-one-weird-trick)

~~~
totalZero
In the Hovnian case, there have been some indications that there will be legal
action if the triggering goes through.

[https://www.bloomberg.com/news/articles/2017-11-15/a-high-
st...](https://www.bloomberg.com/news/articles/2017-11-15/a-high-stakes-hedge-
fund-battle-erupts-over-hovnanian-debt-deal)

[https://www.wsj.com/articles/home-builder-accused-of-
default...](https://www.wsj.com/articles/home-builder-accused-of-default-swap-
scheme-with-blackstone-unit-1512168887)

Even if an individual trader buys stock in a company to manipulate a
derivative and your price impact is beneficial for the shareholders, twenty
executives, and a hundred pension funds, FINRA will not give you a free pass
when they investigate him. No idea how complicated it gets at the
institutional level, but I can't imagine there is a very strong argument for
allowing manipulation to occur in this instance.

Even if the company gets a cash injection, all of the counterparties who sold
protection via CDS will get housed. I don't know who those counterparties are,
but it's easy to imagine that they are trading with money from many sources,
including university endowments, pension funds, insurance companies, and so
forth. So where do you draw the line between beneficial manipulation and
detrimental manipulation?

~~~
valuearb
So now CDS sellers are too big to fail?

I imagine Hovnanian and Blackstone are owned by pension funds, etc, too.

~~~
totalZero
> So now CDS sellers are too big to fail?

Not sure how you came to this conclusion. The point is that you can't argue
"this is good for the company/shareholders/lender" if you're selectively
choosing the winners without mentioning the losers. It's not compelling,
especially not to regulators.

The issue is that if you allow manipulation of derivatives, then the markets
become totally useless and they reward only the large players who have the
resources to make large trades and deals that custom-fit the triggers to their
own payoff profiles.

Many of the counterparties in the derivatives market trade against the banks
where they do business, in effect meaning that banks would be manipulating
their own customers if you allow certain manipulative tactics.

And like it or not, it's an established fact that manipulation in the derivs
market is, broadly speaking, illegal.

~~~
valuearb
Derivatives are legalized gambling. And this wasn’t manipulation, just two
parties doing their fiduciary duties.

~~~
totalZero
> Derivatives are legalized gambling.

I don't agree with you. There is a different utility to commodity futures, for
example, than to bets on horse races or blackjack games. Derivatives allow
tailored hedging of real-world risks. The regulatory stipulations are
different, especially for dealers, and there is a far larger opportunity for
people with predictive skills in the derivatives market.

> And this wasn’t manipulation, just two parties doing their fiduciary duties.

By this logic, any profit from market manipulation would be justified because
it generates a return for investors. Yet the reason these behaviors are
prohibited is because they make the market worse for everyone, arguably
including the long-run returns of those very same investors. "Is it beneficial
to my investors" is a very poor test to answer the question, "is it
manipulation?".

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hacknat
If I were in management I would take the deal from Blackstone, but only on the
immutable condition that Blackstone defray all of the legal losses that may or
may not arise from their proposal. See how much _they_ really believe in this
idea. My guess: probably not a lot.

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DenisM
Does anyone have Blackstone's side of the story here?

Would be interesting to see that for perspective.

------
KasianFranks
This will be nothing compared the crypto battle coming.

