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Dan Alderson

A remarkable second half turnaround in the 24 September Avon Products credit default swap auction shifted the balance from protection sellers to protection buyers.

The Avon auction, hosted by Creditex, produced an initial market midpoint of 63.375 cents. This would have meant protection holders only recouping 36.625 cents — a lower payout than Avon CDS and bonds had projected, with five-year CDS having been quoted at 52.25 points up front ahead of the auction (indicating a 47.75 payout to protection buyers).

But subsequent bidding reduced the final result to only 34, lifting the payout nearly 30 cents to 66.

This was first CDS auction of the year coming at a time of focus on the mechanisms by which CDS are settled. Last week the International Swaps and Derivatives Association published the results of its market-wide consultation on the Credit Derivatives Determinations Committees, which decide whether a credit event has happened and whether/how an auction will be run.

Respondents want a major overhaul of the DC composition, management and processes — including more independent oversight and representation. ISDA appears to be on board with these requests, but expects to take a year before presenting its proposals to DC members.

Also last week, there was disagreement between Americas DC members on which obligations should be permitted into the Avon auction, with Barclays and Goldman Sachs at odds with the rest of the panel over the exclusion of a $405m promissory note.

Barclays, via law firm Milbank, challenged this exclusion in a 12-page document, but the DC denied their request without giving further explanation.

Today’s auction first round featured a wide disparity between dealers in their initial markets. Citi mustered a bid/offer of just 17/27, while other dealers were much higher — Bank of America was prepared to make markets at 70/80.

Second round bidding also offered an anomaly. Physical settlement requests generated just $13.18m open interest to sell bonds into the auction, with Goldman looking to sell $15m, but these were paired against a series of miniscule limit orders starting at just $0.25m. That meant it took 22 limit orders to fulfill the open interest, by which point the price had dropped to 34, the final result.

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