At least one Credit Event under a credit default swap (CDS) was supposed to be simple - "Failure to Pay". The test is objective, easily verifiable and generally not subject to varying interpretations. However, the CDS market has learned that "Failure to Pay" is not simple after all, and the definition has become the focus of recent controversies that threaten the very existence of the CDS product.
In this article, Julia Lu and Richard Lee examine the definitions of “Failure to Pay” and “Restructuring” and the likely cause of recent controversies. They also explore some options to amend “Failure to Pay” to include safeguards to minimize the risk of moral hazards.