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Hedge funds have locked horns over a default at one of Europe’s largest issuers of junk debt, in a fight that will determine whether investors who placed bets against the company’s bonds will receive a substantial windfall or a much smaller payout.
The dispute is over credit default swaps — an insurance-like derivative product designed to provide protection against default — on the debt of Ardagh, one of the world’s biggest producers of glass and metal drinks containers, which recently underwent a contentious restructuring.
A panel of experts that adjudicates disputes in the multitrillion dollar global CDS market has become the target of a fierce lobbying battle, in a rare public spat that pits London-based Arini Capital Management against rival funds.
“This is about having a market that actually works,” said one credit investor with exposure to Ardagh’s CDS. “The product is there to insure people”.
Ardagh was transformed from a local company into a multinational operation spanning Europe, the US and Africa by Irish entrepreneur Paul Coulson, a former accountant known as “The Cooler”. He built Ardagh through a string of debt-funded buyouts, becoming a titan of junk bond markets.
Coulson ceded control of Ardagh to a group of its bondholders in a restructuring formally agreed last October. The deal secured $300mn for the company’s shareholders, including just over $100mn for Coulson himself.
Arini — which was founded by former Credit Suisse star trader Hamza Lemssouguer in 2021 and has grown rapidly to manage more than $11bn in assets — has argued that if certain lower-ranking Ardagh bonds are included in the process to determine CDS payouts, it could produce “arbitrary and absurd results”.
Arini was one of Ardagh’s biggest bondholders and was involved in efforts to secure the restructuring deal. It has also sold large amounts of Ardagh CDS to investors seeking protection against a default and would face higher payouts if the lower-ranking bonds were included, according to several people familiar with the matter.
But London-based Tresidor Investment Management and New York-based Laurion Capital Management this week filed responses challenging Arini’s submission to the so-called Credit Derivatives Determinations Committee, with the former firm arguing that it contains “multiple logical non-sequiturs”.
Arini declined to comment. Tresidor and Laurion did not respond to a request for comment.
The dispute is the latest in a string of skirmishes over the wording and precise legal meaning of CDS contracts, where quirks of corporate restructuring can combine with the dense contracts governing the derivatives to create unexpected outcomes for investors.
The determinations committee, which is composed of experts from banks and funds active in the CDS market, was created in the wake of the 2008 global financial crisis in a bid to create a neutral arbiter to determine when defaults have occurred and how CDS contracts are settled.
Ardagh’s restructuring has already proved contentious for the CDS market, with the committee last year calling in a panel of barristers to conduct an external review to determine if and when a default had occurred. This was only the second time in its history that the determinations committee has brought in outside experts to adjudicate a European CDS default, with the previous review occurring when the Bank of Portugal in effect wiped out bondholders in Novo Banco in 2015.
The dispute over Ardagh CDS stems from the fact that such products do not pay out a fixed amount of money in the event of a default, but instead are designed to compensate for the precise losses bondholders have suffered as a result of a company’s default or restructuring. In order to determine the level of payout, an auction of defaulted bonds is held, with CDS holders receiving the difference between the amount the bonds fetch at auction and their face value.
The determinations committee said last month that it planned to include lower-ranking unsecured Ardagh bonds in this process — a move that could suppress the price at auction and increase the CDS payout. Because of the large amount of Ardagh CDS outstanding, this could trigger payouts stretching into the hundreds of millions of dollars.
But earlier this month Arini filed a challenge, arguing that lower-ranking bonds are not eligible because they have since been converted into equity and should be treated as they would have been if this had already happened when the restructuring was agreed in October — the date at which the determinations committee has decided that a credit event occurred and the CDS contracts were triggered — because at that point, unlike more senior debt, they were in any event destined to disappear.
Fund’s opposing Arini argue that because the bonds were only converted to equity a month after the CDS was triggered, this argument does not stand.
Arini said the committee was trying “to reverse engineer a particular economic outcome for the settlement of the CDS” and that including the unsecured bonds “would turn them into Schrödinger’s Obligations”, where they were both equity and debt at the same time.
If these lower-ranking bonds are excluded, it would mean the auction would consist only of Ardagh’s safer secured debt, which is trading close to face value, leading to smaller payouts.
Tresidor and Laurion filed separate responses to Arini’s challenge on Monday contesting its argument, which Laurion’s lawyers, Millbank, described as “incorrect and unworkably muddy”.
The outcome of the dispute over Ardagh CDS is being closely watched in European credit markets, with many funds that bought protection against a default by Ardagh arguing that it would undermine faith in the financial product if it did not fully reflect losses investors suffered in the restructuring.
