[Exclusive] ‘Zero Recovery’ Emerges in Meta CDS [fn Market Watch]

[Financial News] A “zero recovery” condition has emerged in Korea’s first securitization transaction involving a global big-tech credit default swap (CDS).
The first reference entity, Meta Platforms, has a global credit rating of around AA-, but the structure applies a 0% recovery rate and a 100% loss rate if a credit event occurs, regardless of the actual recovery value of its bonds. It simplifies the settlement process while assuming losses in the most conservative manner. Some concerns have also emerged over the unprecedented structure and contractual terms.
According to investment banks and credit-rating agencies on the 1st, the first Meta CDS securitization transaction being pursued in Korea is considering a “zero recovery structure.” The transaction would determine whether a credit event has occurred based on Meta’s senior debt and assume a 0% recovery rate if one occurs.
This transaction differs from Meta directly issuing won-denominated corporate bonds in Korea. It would convert the credit risk of Meta CDS traded overseas into won-denominated securitized securities through a domestic special-purpose company (SPC), which would then supply them to Korean investors.
A CDS is a derivative that trades the default risk of a specific company. Normally, when a credit event occurs, losses are settled based on the market price or actual recovery value of the reference obligation. For example, if a bond with a face value of 10 billion won is still worth 7 billion won after a credit event, the loss would be calculated at 3 billion won.
Zero recovery simplifies this process. Instead of determining how much can actually be recovered, the contract sets the recovery rate at 0% from the outset. Even if the underlying bond retains considerable value, the contractual loss rate becomes 100% when a credit event occurs.
This is how “AA- rated Meta” and a “100% loss rate” can coexist. Meta’s high credit rating means its probability of default is assessed as low, but if a credit event occurs, a 100% loss rate may still apply. The likelihood of default and the amount lost if default occurs are separate issues.
Credit-rating agencies are paying particular attention to the definition of a credit event. Global CDS contracts are generally based on the standard agreements of the International Swaps and Derivatives Association (ISDA), which specify whether events such as failure to pay, bankruptcy, or debt restructuring qualify as credit events. The scope of the reference obligations, repayment priority, and settlement method are also set out in the contract.
The wording of the contract becomes even more important when zero recovery is included. Even if the actual bond retains recovery value, a 0% recovery rate may apply if the event is recognized as a contractual credit event. Ultimately, determining what constitutes a credit event can affect investors’ losses just as much as Meta’s credit rating.
The repayment priority of the reference obligations is also being assessed. In this transaction, the parties are reportedly discussing a structure that would use Meta’s senior debt to determine whether a credit event has occurred.
An investment banking industry official explained, “Zero recovery is a method that sets the contractual recovery rate at 0% from the outset without determining how much can actually be recovered. This means that even if some money can be recovered from the actual bonds, the contract may treat it as a total loss.” The official added, “Therefore, investors should not look only at Meta’s credit rating. They must also examine what qualifies as a credit event and how that risk has been reflected in the securitized securities.”
As this is Korea’s first case of creating won-denominated securitized securities based on a global big-tech CDS, the product structure and credit-rating methodology developed through the transaction could become a benchmark for subsequent deals. That has drawn considerable attention both inside and outside the industry. Another industry official remarked, “If the credit risks of other global big-tech companies enter Korea’s structured-finance market following Meta, this transaction will effectively become the first test.”


[email protected] Hyun-jung Kim, Kyung-ah Kim Reporter