Econ_May_05_2018

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68 Finance and economics The Economist May 5th 2018
1
I N 2013 Codere, a Spanish gaming firm,
owedmoney it could not repay. Its bonds
were trading at just over half face value.
Blackstone, a private-equity firm, offered it
a cheap $100m loan. But there was a catch.
Blackstone had bought credit derivatives
onCodere’s debt thatwould pay out about
€14m ($19m) if Codere missed a bond pay-
ment. So Codere delayed a payment by a
couple of days to prompt a “technical de-
fault”. Blackstone got its payout; Codere
got its loan and stayed afloat.
On the satirical “DailyShow”, JonStew-
art, the then host, likened the scheme to
the insurance fraud in “Goodfellas”, in
which mobsters insure a restaurant before
blowing it up. But that missed an impor-
tant point. Blackstone did not blowCodere
up—quite the opposite. As it said at the
time, it “provided capital when no one else
would, which allowed the company to live
and fight another day”. The investors who
sold Blackstone credit-derivative contracts
had in effect bet that Codere would not go
bankrupt. Without the loan, it probably
would have. Those investors would still
have paid for their error.
Those machinations pale in compari-
son with Blackstone’s latest financial wiz-
ardry. In 2017 Blackstone bought $333m-
worth of credit derivatives on Hovnanian,
an American construction firm. It offered
Hovnanian cheap financing on condition
that it trigger those derivatives to pay out.
But Hovnanian is in better shape than
Codere. Though its bonds are junk-rated, it
is hardly flirtingwith bankruptcy.
That posed two problems. The first is
that missing a payment would harm Hov-
nanian’s image. But Blackstone found an
ingenious workaround. A condition of the
financing was that a subsidiary of Hovna-
nian bought $26m of its bonds. OnMay 1st
Hovnanian paid other bondholders but
defaulted on those held by the subsidiary.
The second problem is trickier. The de-
rivatives, called credit-default swaps
(CDSs), pay the difference between the no-
tional value of a bond and the lowest price
at which any of the company’s bonds is
trading when the CDS is triggered. This is
usually a good proxy for the haircut inves-
tors would have to take after a firm’s bank-
ruptcy. If it can pay back only half its debt,
its bonds should be trading at around half
face value, and the CDS will cover the rest.
Thatmakes sensewhen a company actual-
ly defaults, and all bond claims fall due.
Hovnanian required a different ap-
proach. Bonds are usually issued “at par”,
meaning investors get back the face value
at the end of the term. In the meantime,
they receive interest (the coupon). The cou-
pon depends partly on how confident in-
vestors are that the loanwill eventually be
repaid in full.
Ifall Hovnanian’s bonds hadbeen trad-
ing close to par, then a technical default
would have resulted in a tiny payout. And
indeed, most were. But Blackstone’s cheap
financing tookthe formofbuying a 22-year
bond Hovnanian had recently issuedwith
a 5% coupon—a combination of interest
and term that even the bluest of blue-chips
could not issue at par. Trading at less than
half face value, it is the reference against
which Blackstone’s CDS will be valued.
Thosewhomust payout are, unsurpris-
ingly, irked. One regulator thinks they have
a point. America’s Commodity Futures
Trading Commission suggests technical
default may count as market manipula-
tion. But company CDSs fall under the Se-
curities and Exchange Commission, which
has said nothing. Courts, so far, have up-
held the actions of Hovnanian and Black-
stone. One of the CDS sellers, Solus Asset
Management, a hedge fund, was denied an
injunction to stop the technical default.
Blackstone says it remains “highly confi-
dent” that its arrangement with Hovna-
nian is “fully compliant with the long-
standing rules of thismarket”.
CDSs were intended as a hedge against
losses fromdefaults, not a bet on a firmde-
ciding to trigger them. But Blackstone’s
machinations seem to have broken the
spirit, rather than the letter, of the rules.
Even Bennett Goodman, the boss of its
credit-investment arm, has expressed his
support for a rewrite. “If people want to
change the rules…because they think it
makes for a more effective market struc-
ture, we are all for it,” he said in March.
That would indeed be good, fellas. 7
Credit-default swaps
Where it’s due
Abondholderfinds a sneakyway to
trigger insurance against default
AS BRITAIN’S prime minister between
2010 and 2016, David Cameron cham-
pioned financial transparency, targeting
anonymous shell companies as the get-
away cars of tax-evaders and money-laun-
derers. On his watch Britain became the
first G20 country to commit to a publicly
accessible register of company owners. Mr
Cameron tried to make British territories
with big offshore financial centres do like-
wise. The arm-twisting stopped when he
stepped down in 2016. But campaigners,
led in Parliament by Labour’s Margaret
Hodge, vowed to keep going. This week
their persistence paid off.
MsHodge andAndrewMitchell, a Con-
servative MP, had tabled an amendment to
an anti-money-laundering bill, which was
designed to force “overseas territories” in
the Caribbean and Atlantic, among them
the British Virgin Islands ( BVI), Bermuda
and the Cayman Islands, to set up public
registers, if they had not already done so,
by the endof2020. Facedwithdefeat in the
House of Commons, the government
dropped its opposition to the amendment,
clearing the way for it to be shoehorned
into the legislation. The House of Lords,
which rejected it in January, is not expected
to do so again.
Themeasure looked a long shot until re-
cently. But that changed with the poison-
ing in Salisbury, a southern English city, of
Sergei Skripal, a Russian ex-spy. The nerve-
agent attack sparked intense scrutiny of
Russian malfeasance, including oligarchs’
use of Britain and its offshore satellites to
wash their dirty money. “It’s all down to
the Salisbury effect,” says a lobbyist.
Global Witness, a campaign group,
hailed the breakthrough as the “biggest
move against corruption in years”. The af-
fected territories—under British sovereign-
ty but not actually part of the United King-
dom—are livid. They say it breaks a
long-standing constitutional arrangement,
Cracking down on tax havens
The Salisbury effect
Transparency is being forced on Britain’s overseas territories
Blue-skies regulation
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