Greece has gone ahead with the first phase of their restructuring - Getty Images via @daylife
UPDATE 2 (2:48 p.m.): ISDA has now declared that Greece's restructuring does represent a default, meaning credit default swaps will trigger. Read the statement here.
UPDATE (2:43 p.m.): An ISDA spokesman told Forbes no decision has been reached regarding on whether Greece's restructuring qualifies as a credit event, which would in turn trigger CDS protection.
A report by Derivatives Intelligence published around 2:00 PM New York time said the ISDA had indeed considered the PSI/debt restructuring deal a credit event. Their report from the supposed ISDA release, noting the application of collective action clauses had "reduced" bondholders' ability to receive payments, and that an auction for outstanding CDS would be held March 19.
Kevin Dugan, the journalist who published the initial report, tweeted a picture of the ISDA's supposed press release. Click here for the picture.
Greece did it! The Hellenic Republic executed the highly controversial PSI or debt restructuring deal, getting 85.8% of holders of Greek-law governed bonds and 69% of foreign-law bonds to tender. All eyes will now fall on the ISDA as the Greek government uses collective action clauses (CACs) to force holders of bonds governed by domestic law to take the debt swap, potentially triggering credit default swaps (CDS).
While Greece hasn’t missed a bond payment yet, it has effectively defaulted by forcing a 74% haircut on those creditors that held out, as Fitch’s calculations in their recent downgrade of Greece’s sovereign rating to “selective default” show. The question of a Greek default may appear superfluous to some, given the country is relatively small and has been bailed out, but the resolution of the situation will set historical precedents that could take on massive importance if other peripherals, particularly Spain and Italy, face serious financing problems.
For more analysis, read Greek Default Provides Temporary Relief As EU Crisis Marches On.
And that is why the International Swaps and Derivatives Association's decision on CDS is actually transcendental. Greece announced that holders of €152 billion of bonds governed by Greek law, of the approximately €177 billion issued, voluntarily tendered their bonds and accepted a 74% haircut. Also included in the deal were holders of laws governed by foreign law, generally British or Japanese, whom tendered €20 billion or 69% of bonds outstanding.
Using retroactively inserted CACs, Greece can force bondholders governed by domestic law to take the deal, as long as they meet a certain threshold, which they did: beyond the 85.8% of those bondholders that tendered their bonds, an additional 5.3% (about €9.38 billion in face value) voted to force the restructuring terms, without tendering their bonds. Presumably, that 5.3% consists of bondholders that bought CDS protection, and need the CAC implementation to trigger that protection.
At the end of the day, this means Greece is forcing 9.9% of bondholders under domestic law to both accept the retroactively inserted CACs and to take a 74% haircut (according to Fitch’s calculations). Just to clarify, an additional 5.3% held out but voted to enforce the CACs, presumably because they bought CDS to cash-in on Greece’s sovereign debt crisis.
It’s all down to the ISDA now. The group has been under fire by the media for failing to consider Greece in default when it was clearly imposing a massive haircut on its creditors. To the ISDA’s defense, no bondholder had actually suffered a haircut. As of Monday, when Greece implements the swap, this will have occurred, against the will of 9.9% of those bondholders.
The ISDA was set to meet at 1PM London time on Friday to figure out if a restructuring credit event had occurred, a circumstance that would trigger CDS. Both Nomura and Barclays have come out expecting the ISDA to rule in favor of a credit event, thus triggering CDS protection.
The net notional value of CDS outstanding is relatively small, around $3.2 billion. Barclays’ analysts considered the process to be “relatively uneventful” given how small the actual liabilities are. But they are missing the point. As the ISDA has made clear in the past, these products are in their infancy and are in a process of evolution. The Greek restructuring is a defining moment for CDS and other derivative products, giving the ISDA’s decision value in terms of precedence, much like a in a legal system based on jurisprudence. The net notional value of total CDS outstanding is $15.7 trillion according to DTCC, that's larger than the U.S. economy.
The issue of moral hazard is unavoidable within the ISDA. Among the parties voting to determine if there will be a credit event in Greece are institutions like Goldman Sachs, Morgan Stanley, JPMorgan, Deutsche Bank, BNP Paribas, and Societe Generale. Hedge funds like Elliot Management, Citadel, and D.E. Shaw are part of the decision-making group too. Some of these institutions have tendered their bonds, others, probably, have placed their bets on a Greek default.
Whatever the ISDA decides, the future of CDS is on the table. And, if the European sovereign debt crisis takes a turn for the worse, as it probably will, and Spain or Italy come under fire by bond vigilantes, then the ISDA’s decision on Greece will take on added importance.
For more analysis, read Greek Default Provides Temporary Relief As EU Crisis Marches On.
