Oct. 22 (Bloomberg) -- Banks and hedge funds that provided investors with credit insurance on Thomson SA’s bonds may have to pay as much as 20 cents in the euro to settle the contracts in the first test of rules to streamline the market.

Credit-default swap traders set an initial recovery value of as low as 80 percent on the French electronics company’s bonds at auction today, and sellers of protection have to compensate investors for the balance. A final value for the debt will be set at 2 p.m. in London, according to Markit Group Ltd. and Creditex Group Inc., which are administering the auctions.

The credit insurance was triggered after Paris-based Thomson deferred payments on $72.5 million of 6.05 percent privately placed notes earlier this year. Traders ruled Aug. 12 that the deferral was a so-called restructuring credit event, the first in Europe since the “Small Bang Protocol” was implemented in July to standardize contracts.

“Thomson’s restructuring credit event should give an indication of how well the Small Bang works,” said Matthew Leeming, a member of the credit derivative and quantitative strategy team at Barclays Capital in London.

Three auctions took place this morning setting initial recovery values for Thomson bonds in three maturity groups, or buckets. Notes with a maturity of 2 1/2 years were given an initial recovery value of 91.25 percent, five-year bonds were valued at 80.375 percent and 7-1/2 debt was valued at 80 percent, according to Markit and Creditex.

Averting Bankruptcy

As a test case for unwinding credit insurance after a restructuring, the settlement of Thomson’s default swaps has spurred speculation it will make it tougher for companies to re- organize debt after some investors were excluded from the auctions.

The process to unwind the credit-default swaps “has taken more time than expected and is now anticipated to be completed by the end of October,” Thomson, the 115-year-old owner of film processor Technicolor Inc., said in a statement today.

The company restructured more than 2 billion euros ($3 billion) of debt in July to avert bankruptcy, and it said today that it won more senior creditor backing since then.

“It’s the first credit restructuring event in Europe” and “the fact the company is still negotiating with creditors on the restructuring adds a lot of uncertainty to the situation,” said Teo Lasarte, a credit strategist at Bank of America-Merrill Lynch in London.

Private Market

Credit-default swaps are privately negotiated financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt or to hedge against losses. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Investors bought or sold more than 11,000 individual swaps contracts worth a net $2 billion on Thomson debt as of Aug. 14, according to data compiled by Depository Trust & Clearing Corp. which runs a central registry that captures most trading.

Thomson fell 8 euro cents, or 5.9 percent, to 1.27 euros as of 1:18 p.m. in Paris.

The company’s estimated cash position at the end of the third quarter was 551 million euros, up from 511 million euros on June 30, it said in today’s statement. Estimated net financial debt was 2.17 billion euros as of Sept. 30, compared with 2.31 billion in the previous period. Third-quarter sales fell 20 percent on a continuing-operations basis to 803 million euros, the company said.

The Small Bang allows credit-default swap contracts triggered by debt restructurings to be settled at auction, according to the International Swaps & Derivatives Association, the New York-based industry group. It’s part of an overhaul of the $28 trillion credit-default swaps market that includes moving transactions to a clearinghouse and follows earlier reforms carried out under the “Big Bang.”

To contact the reporter on this story: Patricia Kuo in London at pkuo2@bloomberg.net

Last Updated: October 22, 2009 07:25 EDT