Veritas – Why CDS payouts on Greece would be good for all

Ask European politicians ‘what is the most dangerous thing financial engineers have made in recent years?’ and many will give you just three letters: ‘CDS’.

CDS stands for ‘credit default swap’, an instrument to insure against debt or bond issuers defaulting on their borrowings.

But for various European parliamentarians, CDS stands for all that is wrong with the financial community.

It allow speculators to ‘bet on misery’, they argue, and even worse, to place that bet without having to have a counterbalancing long position (so the CDS is not a hedge in case the ‘good news’ bet fails).

Some governments have banned one-way punting on government debt, and only allowed it if CDS holders also have an economic interest in the instrument that the CDS refers to.

Either way, the whole CDS debate has a focus on Thursday, when private holders of Greek debt vote on whether to accept or refuse a proposed reduction in face value of their positions.

If more than 25% disagree – so the force majeur on minority dissenters cannot be enacted – it is very hard to foresee how a ‘credit event’ and associated payments to CDS holders, can be avoided.

Two weighty bodies are already clashing over this.

Standard & Poor’s already rates Greece as in ‘selective default’, implying the agreement with debt holders marks a ‘credit event’.

But last Thursday, the International Swaps and Derivatives Association ruled, the situation does not trigger CDS payouts.

It said holders of Greek law bonds had not been subordinated to the ECB, “therefore a restructuring credit event has not occurred”. ISDA added it had received no evidence of an agreement between Greece and holders of private Greek debt that would constitute a credit event, either.

For clarity, ISDA had also noted that a ratings agency putting a bond in ‘default’ did not necessarily mark a credit event, either.

“Well, what does then?” CDS holders might ask.


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