Italy could face more swap terminations

Italian politicians claim Morgan Stanley’s swap termination in January will be a one-off – but dealers say Italy’s debt office is subject to other clauses that could have the same effect

Italian politicians were involved in a tense exchange last month over four derivatives trades between the Dipartimento del Tesoro – the country’s debt office – and Morgan Stanley, which were terminated by the US bank in January, forcing Italy to pay out €2.567 billion.

That was a unique situation, according to Italian education undersecretary Marco Rossi Doria, whose remarks were published in parliamentary transcripts on March 15. He said the trades contained alternative termination event (ATE) clauses, allowing Morgan Stanley to close out if Italy was downgraded below a certain threshold. The Tesoro has no other trades containing ATEs, Doria claimed.

That may be true – but dealers say it is unlikely to be the whole story. ATEs are only one type of clause allowing counterparties to terminate a trade – contracts can also include options allowing one or both counterparties to terminate at specific points during the life of a trade, also known as break clauses. If breaks exist in trades with the Tesoro, other banks that are in-the-money could choose to follow Morgan Stanley’s example.

One European banker that has seen the details of a number of outstanding trades between the Tesoro and its other dealers claims at least two contain breaks, one of which is exercisable in a matter of months, he says.

Other banks contacted by Risk refused to say whether their own trades with the Tesoro contain breaks, but two said it was safe to assume some banks do have those options. “Do I think there are break clauses in trades with Italy? Yes, I do. There are some large portfolios out there, with some very long-dated, uncollateralised trades, so there’s a high probability that some banks will have these clauses in the contracts,” says one head of credit value adjustment (CVA) trading at a US bank.

Sovereigns do not like to be subject to break clauses. Four debt offices contacted by Risk said one or more of their dealers have recently tried to insert breaks into trades. In each case, the debt office refused.

However, according to the European banker, some of the Tesoro’s swaps do include breaks because it traditionally uses swaps for duration management – paying fixed rates to guarantee its long-term cost of funding – and some of its outstanding trades are very long-dated, going out to as much as 40 years in tenor. “Because of the very long-dated nature of their trades, some banks have insisted on break clauses,” he says.

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