Solus was free to offer Hovnanian funding with more favorable terms and the agreement to not default. And if GSO and Solus want to go back and forth offering better and better terms then in the end you have a viable company that's leveraged CDS to get additional funding at good terms.
I think a much sketchier case is what Aurelius did to Windstream. There you have no benefit being created on the back of CDS engineering, you just have a hedge fund who drove a viable business into bankruptcy against the wishes of the primary bondholders.
Conceptually, the CDS market is useful. If I do a bunch of business with a company and them going bankrupt would cause me financial problems then I can use CDS to hedge against that possibility. I don't know how you can prevent this kind of engineering though. I think it's easier to prevent what Aurelius did to Windstream. But the GSO/Hovnanian deal seems much harder to regulate.
Maybe instead we just decide that it was actually a good thing and going forward people should be aware that it's a possible outcome? The risk of default isn't just the risk that the company on its own defaults, but also the risk that the company defaults and can't find outside funding. If people are expecting that eventuality then the CDS market should settle in a spot that prices in the possibility of CDS buyers or sellers offering refinancing.
In an already inefficient market, it's also very hard to price the possibility/structure of these games as it's not like the company can publicly shop around deals for this. In the case of the HOV deal, issuing new bonds to game CDS deliverables was unprecedented and IMO just total nonsense.
The Commodity Futures Trading Commission labeled a similar case as "possible market manipulation", so there definitely is something very fishy going on this type of markets. I'm talking about the "manufactured credit default" of US house-builder Hovnanian. From here [1]:
> A “manufactured default” of a US housebuilder that caused uproar in the credit derivatives market has been called off, after Blackstone-backed hedge fund GSO and Solus Asset Management settled a legal dispute over the trade.
> GSO had agreed to refinance some of housebuilder Hovnanian’s debt at a favourable rate, on the ususual condition that the company miss a payment on some of its bonds. GSO had hoped to profit from credit default swaps that would pay out if Hovnanian defaults.
The Hovnanian deal eventually fell through in later 2018, but only last week did the industry's regulatory body (the International Swaps and Derivatives Association) propose some measures to combat this type of actions.
[1] https://www.ft.com/content/c184dd72-6457-11e8-90c2-9563a0613...