Restructuring

Restructuring is a credit event used in many credit derivatives. It can be triggered when a reference entity restructures its debt. Three main definitions of restructuring are used: restructuring (old R), modified restructuring (mod R) and modified modified restructuring (mod mod R). In addition, credit default swaps written on high yield corporates are usually documented without restructuring.

Old R

The popular name for restructuring as defined in the 1999 credit derivative definitions. This allows the credit event to be triggered when a debt obligation is restructured, for example, by having interest payments reduced, having its principal amount reduced, having its maturity extended, becoming subordinated to another obligation or having its currency changed. There is no maturity limitation on the kind of obligations that can be delivered following this version of restructuring. Old R is currently used for most emerging market credit default swaps as well as for Japanese credits.

Modified restructuring (mod R)

A form of the restructuring credit event used for credit default swaps written on North American and Australian investment grade corporates and financials. The credit event is referred to in credit derivatives documentation as restructuring maturity limitation and fully transferable obligation.

In trades documented using mod R, which was introduced in 2001, a credit event can be triggered by the same events as for old R. However, unlike with old R, not all obligations can be delivered following the credit event.

Under mod R, obligations with a maturity beyond a certain date cannot be delivered. The date, known as the restructuring maturity limitation date, is defined as the earlier of the longest maturity of any restructured bond or loan and 30 months after the restructuring takes place. The maturity limitation feature is designed to reduce the protection buyer’s option to deliver long-dated bonds that may be trading at a discount to shorter dated debt.

The other main feature of mod R is that deliverable obligations must be ‘fully transferable’. That is, there must be no restrictions on the type of investors that can hold the obligations, and there must be no requirement for the issuer to give approval for an investor to buy its obligations. (In a distressed situation, a company often prefers its liabilities to be held by passive or sympathetic investors rather than aggressive value investors such as distressed debt hedge funds.) This feature is included because obligations that are less than fully transferable are likely to trade at a discount to those that have full rights attached.

Modified modified restructing (mod mod R)

A form of the restructuring credit event used for credit default swaps written on European corporates and financials. The credit event is referred to in credit derivatives documentation as modified restructuring maturity limitation and conditionally transferable obligation. It is similar to modified restructuring, but has two important differences.

First, the restructuring maturity limitation date is set at 60 rather than 30 months after the restructuring. Second, whereas mod R requires a deliverable obligation to be fully transferable, mod mod R allows obligations to be delivered so long as they are ‘conditionally transferable’. This wider definition of transferability allows even so-called consent-required loans to be deliverable obligations provided they include language stating that consent may not be unreasonably withheld or delayed. This is especially relevant for European loans, which often have clauses preventing transfer without the borrower’s consent.