ISDA May Reconsider Greek Swaps

Collective action clauses could lead to another vote on whether swaps were triggered.

Holders of credit-default swaps on Greek bonds shouldn’t tear up their contracts after yesterday’s ruling against a payout. The International Swaps & Derivatives Association said the swaps hadn’t been triggered by the European Central Bank’s exchange of Greek bonds for new securities exempt from losses taken by private investors. The group will now probably be asked to determine whether collective action clauses, or CACS, being used by Greece to impel investors to participate in a wider exchange of bonds that would trigger the swaps.

“They will have to enforce CACS,” said Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam. “At that point the exchange will become coercive and that will be a restructuring event for CDS.”

The 130 billion-euro ($170 billion) bailout for Greece is testing the sanctity of the market for credit-default swaps and their effectiveness as a hedge against losses on government bonds. Policy makers including former ECB President Jean-Claude Trichet have opposed paying the contracts because they’re concerned that traders will be encouraged to bet against failing nations and worsen Europe’s debt crisis.

Contracts tied to the debt of Greece signal a 95 percent probability of default.

Such thinking is misdirected, according to Nicholas Spiro, managing director of Spiro Sovereign Strategy in London. A settlement on Greek swaps may bolster confidence in the $258 billion sovereign insurance market and help boost the government bond market, he said. Efforts to circumvent a trigger risk undermining credit markets, Spiro said.

“The sovereign CDS market is crying out for an injection of confidence because we are by no means out of the woods,” Spiro said. “It’s very important, particularly in much larger bond markets like Italy and Spain, that investors’ hedges are perceived to be credible.”

European leaders agreed to provide capital faster for the planned permanent bailout fund in a concession to international pressure to strengthen the bloc’s defenses against the debt crisis. Euro governments might pay the first two annual installments into the 500 billion-euro fund this year and complete the capitalization in 2015, a year ahead of schedule. A decision will come later today.


‘One Final Vote’

The ECB’s exchange of Greek bonds didn’t constitute subordination of private investors, one of the criteria for a payout under a restructuring event, ISDA said. The group’s determinations committee wouldn’t rule out a credit event “at a later date,” according to the statement.

"We expect the next few days, perhaps next few weeks, to ultimately send the ISDA committee back for one final vote,” Pacific Investment Management Co.’s Bill Gross said yesterday in a Bloomberg television interview on “Surveillance Midday” with Tom Keene.

Pimco is part of the ISDA determinations group along with banks and investors including JPMorgan, Barclays Plc, BlueMountain Capital Management LLC and D.E. Shaw & Co., according to ISDA’s website.

Greece has committed to reducing national debt to 120 percent of gross domestic product by 2020, from 160 percent last year. A negotiated debt swap, known as private-sector involvement, or PSI, will slice 100 billion euros off more than 200 billion euros of privately held debt if all investors participate.

The government said Feb. 24 it’s seeking a 90 percent participation rate and set a 75 percent rate as a threshold for proceeding with the transaction. Investors are paying $7.3 million in advance and $100,000 annually to insure $10 million of Greek debt for five years. Greek 10-year bonds fell to a record 19.14 cents on the euro after yesterday’s ruling.

The recovery in an auction may be between 20 cents and 25 cents, Morgan Stanley analysts led by Paolo Batori wrote in a Feb. 27 note.

Private investors have until March 8 to tender their bonds, and the exchange for a majority of securities will be settled on March 12. Greece has said it may activate collective action clauses to bind holdouts.


Funding for Portugal

“ISDA clearly has indicated that that would be a CDS trigger,” said David Nowakowski, credit strategist at Roubini Global Economics LLC in London. “If they’re not triggered, it’s not the end of the CDS market. In corporates there are lots and lots of exchanges, sometimes distressed exchanges, that don’t trigger CDS.”

While Greece’s debt restructuring is the biggest ever, the volume of credit-default swaps on the line has tumbled. The net amount of debt protected is no more than for some companies and represents less than one percent of the nation’s bonds and loans outstanding.

Swaps on Greece (CDNNGRCE) now cover $3.25 billion of debt, down from about $6 billion last year, according to the Depository Trust & Clearing Corp. That compares with a swaps settlement of $5.2 billion on Lehman Brothers Holdings Inc. in 2008.

Greece’s debt restructuring, which triggered a downgrade to selective default by S&P this week, may make it harder for other indebted euro nations such as Portugal to fund themselves, said Moritz Kraemer, head of sovereign ratings at S&P in London.

“It ceased to be about Greece a long time ago,” Spiro said. “It’s all about making sure this tale of woe does not repeat itself elsewhere in the periphery. A payout is very likely. This is really about the timing.”


Bloomberg News


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