CDS and the Resolution of Financial Distress

Abstract:     
Over the last decade, the availability of credit default swaps (CDS) has dramatically transformed the markets for credit insurance by providing participants efficient avenues through which to share credit risks. These risk-sharing benefits notwithstanding, the growth of credit default swaps (CDS), contracts that allow creditors to hedge their default exposure to the debtor or to make leveraged bets on a particular firm’s creditworthiness, threatens to complicate the resolution of distress by separating economic and legal ownership interests in a way that existing reorganization structures have yet to adapt to.

In this article we discuss the issues that arise with CDS in the context of distress resolution and consider the possible ways in which they may be addressed. Using reorganization under chapter 11 bankruptcy to demarcate our discussion into a set of pre-bankruptcy and post-bankruptcy issues, we review the legal and finance thinking on this issue, supplementing it with the relatively modest empirical evidence available to date.

Number of Pages in PDF File: 17

Keywords: CDS, financial distress, derivatives, swaps, empty creditor, ISDA, chapter 11, restructuring

JEL Classification: K20, K23, G34, G32, G33

Accepted Paper Series