7 ms·

Goldman Traders Are Caught Up in a Bizarre, Tense Hedge Fund Battle

143 points by techolic 9y ago

totalZero 9y ago
> 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 9y ago
  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/blackstone-made-money-on-credit-default-swaps-with-this-one-weird-trick https://www.bloomberg.com/view/articles/2013-12-05/blackston...
  - totalZero 9y ago
    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-stakes-hedge-fund-battle-erupts-over-hovnanian-debt-deal https://www.bloomberg.com/news/articles/2017-11-15/a-high-st... https://www.wsj.com/articles/home-builder-accused-of-default-swap-scheme-with-blackstone-unit-1512168887 https://www.wsj.com/articles/home-builder-accused-of-default... 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?
    - whatok 9y ago
      I've read the Solus letter and like I said earlier, no comment on legality as that's not my domain. Just wanted to point out previous BX case.
    - valuearb 9y ago
      So now CDS sellers are too big to fail? I imagine Hovnanian and Blackstone are owned by pension funds, etc, too.
      - totalZero 9y ago
        > 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 9y ago
        Derivatives are legalized gambling. And this wasn’t manipulation, just two parties doing their fiduciary duties.
        totalZero 9y ago
        > 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?".
- DenisM 9y ago
  A company that accepts this sort of a deal is basically trading its reputation for cash. Their CDS in the future will be more expensive, affecting their contract negotiation position. but they are willing to take that future hit for the present ability to survive. I don't see it as obviously wrong, unless the CDS contract itself stipulates otherwise (e.g. multiple damages in case of "voluntary" trigger) or there being a statutory requirement to this effect.
  - runeks 9y ago
    Excuse my ignorance on the subject, but isn’t the CDS issued and traded by third parties unrelated to the company it pertains to? I don’t see how the company in question has any moral obligation to not take this deal, nor do I see why it would affect future CDSs, which will almost certainly add a clause that prevents this from happening.
    - whatok 9y ago
      CDS are traded in standard contracts and it would require a lot committee-ish type work to get things changed along with the fact that I'm not even sure how you would define this type of trade in a clear way. Really doesn't happen overnight [0] As far as the issuer goes, issuers get a reputation for fucking over creditors and that makes it hard for them to tap markets in the future (except in these yield hungry days..). People really don't forget about this kind of stuff. [0] https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-credit-derivatives-definitions/ https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-cre...
    - totalZero 9y ago
      Liquidity in the CDS market can help creditors hedge their debt to the company in question, so -- setting aside the moral question -- doing something erratic with the derivative market on their own credit would likely hurt their ability to borrow in the future. Creditors would be less confident about hedging, and would offer credit with less favorable terms to compensate.
chollida1 9y ago
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.
- whatok 9y ago
  RE: 1, single name bespoke CDS are rarely traded nowadays especially given that more and more names are cleared now.
- dogruck 9y ago
  This sounds like a fairly obvious scenario that the lawyers who define the CDS would’ve considered. Is that true?
  - dboreham 9y ago
    I was thinking the same thing, based on some discussion we had about a big contract we entered into that can terms where if we as the supplier got into financial difficulty, our customer could release our code from escrow and run it themselves. The concern was that the customer might deliberately try to push us into financial difficulty (e.g. by not paying us on time) as a way to in effect permanently avoid paying for our service. So our legal team added wording to the effect of "except if you caused it".
hacknat 9y ago
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.
DenisM 9y ago
Does anyone have Blackstone's side of the story here? Would be interesting to see that for perspective.
KasianFranks 9y ago
This will be nothing compared the crypto battle coming.

143 points by techolic 9y ago

> 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 9y ago
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/blackstone-made-money-on-credit-default-swaps-with-this-one-weird-trick https://www.bloomberg.com/view/articles/2013-12-05/blackston...
- totalZero 9y ago
  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-stakes-hedge-fund-battle-erupts-over-hovnanian-debt-deal https://www.bloomberg.com/news/articles/2017-11-15/a-high-st... https://www.wsj.com/articles/home-builder-accused-of-default-swap-scheme-with-blackstone-unit-1512168887 https://www.wsj.com/articles/home-builder-accused-of-default... 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?
  - whatok 9y ago
    I've read the Solus letter and like I said earlier, no comment on legality as that's not my domain. Just wanted to point out previous BX case.
  - valuearb 9y ago
    So now CDS sellers are too big to fail? I imagine Hovnanian and Blackstone are owned by pension funds, etc, too.
    - totalZero 9y ago
      > 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 9y ago
        Derivatives are legalized gambling. And this wasn’t manipulation, just two parties doing their fiduciary duties.
        totalZero 9y ago
        > 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?".
DenisM 9y ago
A company that accepts this sort of a deal is basically trading its reputation for cash. Their CDS in the future will be more expensive, affecting their contract negotiation position. but they are willing to take that future hit for the present ability to survive. I don't see it as obviously wrong, unless the CDS contract itself stipulates otherwise (e.g. multiple damages in case of "voluntary" trigger) or there being a statutory requirement to this effect.
- runeks 9y ago
  Excuse my ignorance on the subject, but isn’t the CDS issued and traded by third parties unrelated to the company it pertains to? I don’t see how the company in question has any moral obligation to not take this deal, nor do I see why it would affect future CDSs, which will almost certainly add a clause that prevents this from happening.
  - whatok 9y ago
    CDS are traded in standard contracts and it would require a lot committee-ish type work to get things changed along with the fact that I'm not even sure how you would define this type of trade in a clear way. Really doesn't happen overnight [0] As far as the issuer goes, issuers get a reputation for fucking over creditors and that makes it hard for them to tap markets in the future (except in these yield hungry days..). People really don't forget about this kind of stuff. [0] https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-credit-derivatives-definitions/ https://corpgov.law.harvard.edu/2014/08/24/new-isda-2014-cre...
  - totalZero 9y ago
    Liquidity in the CDS market can help creditors hedge their debt to the company in question, so -- setting aside the moral question -- doing something erratic with the derivative market on their own credit would likely hurt their ability to borrow in the future. Creditors would be less confident about hedging, and would offer credit with less favorable terms to compensate.

chollida1 9y ago

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.

whatok 9y ago
RE: 1, single name bespoke CDS are rarely traded nowadays especially given that more and more names are cleared now.
dogruck 9y ago
This sounds like a fairly obvious scenario that the lawyers who define the CDS would’ve considered. Is that true?
- dboreham 9y ago
  I was thinking the same thing, based on some discussion we had about a big contract we entered into that can terms where if we as the supplier got into financial difficulty, our customer could release our code from escrow and run it themselves. The concern was that the customer might deliberately try to push us into financial difficulty (e.g. by not paying us on time) as a way to in effect permanently avoid paying for our service. So our legal team added wording to the effect of "except if you caused it".

hacknat 9y ago

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.

DenisM 9y ago

Does anyone have Blackstone's side of the story here? Would be interesting to see that for perspective.

KasianFranks 9y ago

This will be nothing compared the crypto battle coming.