ISDA: Greece deal triggers $3B in default swaps

A committee of credit-default swaps traders will expedite an auction to settle about $3 billion of contracts tied to Greece after the nation took steps to force investors to participate in the biggest sovereign-debt restructuring in history. Traders will hold the auction March 19 to “maximize” the number of bonds that can be used to set payout amounts, the New York-based International Swaps and Derivatives Association said on the committee’s website yesterday. Auctions, which set a recovery value on the underlying bonds, typically are held about a month after credit events are triggered. The viability of credit swaps as a hedge for about $257 billion of government debt was questioned after ISDA rejected a request on March 1 to declare whether the swaps were triggered because the restructuring effectively subordinated private investors to the European Central Bank. Banks, hedge funds and institutional investors use swaps to protect against losses or to speculate on creditworthiness. “It’s important to keep investor confidence in this instrument as it will affect the ability of sovereigns to issue bonds,” according to Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam, who said the decision will “restore confidence” in the market. “If you want to attract investor demand, you have to offer them an instrument that will allow them to hedge exposure, and CDS is the best instrument for that.” Collective Action Greece’s use of collective action clauses, or CACs, in its debt restructuring triggers payouts on the contracts, ISDA’s determinations committee said in a statement yesterday. Before the ruling, the cost of five-year Greek swaps rose to a record $7.68 million upfront and $100,000 annually to insure $10 million of debt. Investors with 95.7 percent of Greece’s privately held bonds will participate in the swap after the CACs are triggered, the Finance Ministry said. Bondholders tendered 152 billion euros ($199.5 billion) of Greek-law bonds, or 85.8 percent, and 20 billion euros of foreign-law debt. Greece extended its offer to holders of non-Greek law bonds to March 23, after which sweeteners will no longer be available. ‘Preliminary List’ “ISDA has already been working with members to put together a preliminary list” of bonds that can be used in the auction, ISDA General Counsel David Geen said on a conference call with reporters yesterday. The committee is considering “the range of obligations that are either currently outstanding or may be outstanding once some of these exchanges occur,” ISDA Chief Executive Officer Robert Pickel said on the call. In a restructuring credit event, investors have the right to choose whether to settle their contracts. Policy makers including former ECB President Jean-Claude Trichet opposed payouts on Greek swaps on concern traders would be encouraged to bet against failing nations and worsen the region’s debt crisis. A swaps trigger “raises the question of which country is next and which banks are most exposed,” Hank Calenti, a bank analysts at Societe Generale SA in London, wrote in a note. “Less than six months ago we had the head of the ECB exhorting that there must be no credit event on Greece.” Swaps Stigma While policy makers had hoped to achieve debt sustainability in Europe’s most indebted nations without triggering default swaps, political determination to avoid the stigma of a credit event waned as Greece struggled to meet the terms of its bailout. Standard & Poor’s downgraded the nation to selective default on Feb. 27 after the government retroactively inserted CACs into bond terms. Moody’s Investors Service, which downgraded the nation’s sovereign rating to its lowest level of C on March 2, said today it considers the nation to have defaulted. Greece reached its target for participation in the debt restructuring after using CACs to force the hand of holdouts. “I’ve been surprised throughout at the strong desire not to trigger CDS,” said Elisabeth Afseth, a fixed-income analyst at Investec Bank Plc in London. “This should be good for anyone seeking protection elsewhere, such as Spain or Italy.” ISDA’s Geen said the determination should resolve concerns that credit swaps aren’t effective hedges. Issue ‘Moot’ “That issue, of course, is moot at this point,” he said, “but we think it’s a fair question.” ISDA definitions contain “a number of conditions that must be met before a credit event can occur, which are important to balance the interests of the buyer and the seller,” he said. Credit-default swaps on Greece cover $3.16 billion of debt, down from about $6 billion last year, according to the Depository Trust & Clearing Corp. That compares with a swaps payout of $5.2 billion on Lehman Brothers Holdings Inc. in 2008. The actual payout on Greece will be “much smaller” than the net amount reported by DTCC, Pickel said. A gross $68.9 billion of contracts were outstanding as of March 2 before accounting for offsetting trades. While there were concerns at the time about a daisy chain of losses if counterparties failed to meet their commitments, the settlement of swaps guaranteeing debt of Lehman, as well as Fannie Mae and Freddie Mac, were “orderly” and caused no major disruptions for the market, according to regulators. Restructuring Events Swaps on western European governments can pay out on a credit event triggered by failure to pay, restructuring or a moratorium on payments. A restructuring event can be caused by a reduction in principal or interest, postponement or deferral of payments or a change in the ranking or currency of obligations, according to ISDA rules. Any of these changes must result from deterioration in creditworthiness, apply to multiple investors and be binding on all holders. The determinations committee which decides whether a credit event has occurred consists of representatives from 15 dealers and investors. The group, which includes Deutsche Bank AG (DBK), Pacific Investment Management Co. and Morgan Stanley, rules after a request is made by a market participant. The trigger is “a better outcome for markets,” said Jason Brady, a managing director at Thornburg Investment Management Inc., which oversees about $81 billion from Santa Fe, New Mexico. “It means people got what they expected. Yeah, Greece defaulted. We’re not changing that fact at all; why make other parts of the market say something different just because you don’t like that part of the market?”