CDS - Pari passu and credit event

CFA Level II Fixed Income
#1

In CFA Level II Fixed income - reading 36 Types of CDS section (2.1), it says “…the reference obligation is not the only instrument covered by the CDS. Any debt obligation issued by the borrower that is pari passu (ranked equivalently in priority of claims) or higher relative to the reference obligation is covered.”

At the same type, in (2.3) Credit and Succession Events, it says “Another credit event recognized in standard CDS contracts is failure to pay, which occurs when a borrower does not make a scheduled payment of principal or interest on any outstanding obligations after a grace period, without a formal bankruptcy filing.”

Based on these two statements, I’m confused on what exactly pari passu default refers to. From the failure to pay section, it seems like any payment failure of the bond issuer - e.g. a subordinated debt payment failure could trigger the credit event and then we need to use cheapest to deliver method to calculate estimated payoff. However, from the pari passu default part, it seems like it is saying only the default on the same seniority and higher debt would trigger a default. Can anyone explain which one to use and did I misunderstand anything?

Thanks in advance.

#2

I actually have the same question. The way I initially thought about it is that it depends on the CDS you are holding. The pari passu rule applies at the CDS level. However, the credit event may not have an impact on the CDS you are holding. So if the reference entity fails to pay on its subordinated debt (or any other debt), then this would trigger a credit event but it would only impact those who hold a CDS on the entity’s subordinated debt. In other words, your senior CDS does not cover subordinated debt and may not be impacted by the credit event. I guess it may give rise to an general increase in spread which would benefit the short party but it would not result in default settlement for senior debt holders. I have no idea if this makes sense though. Anyone can clarify?