The EU Summit has determined that holders of Greek bonds will be faced with a haircut of 50% on their exposure. But it still looks extremely unlikely that even a haircut of this magnitude will trigger a credit event on the CDS written against these bonds.
The EU Summit determined that holders of Greek bonds will be faced with a haircut of 50% on their exposure. But it still looks extremely unlikely that even a haircut of this magnitude will trigger a credit event on the CDS written against these bonds. David Geen, general counsel at ISDA has been widely quoted today as stating that “As far as we can see it’s still a voluntary arrangement and therefore we are in the same position as we were with the 21% when that was agreed. The percentage (of losses) as far as the analysis for CDS purposes goes, doesn’t change things. Typically a voluntary arrangement won’t trigger the CDS.”
ISDA released a statement 27 October explaining its position. “The determination of whether the eurozone deal with regard to Greece is a credit event under CDS documentation will be made by ISDA’s EMEA Determinations Committee when the proposal is formally signed, and if a market participant requests a ruling from the DC,” it said. “Based on what we know it appears from preliminary news reports that the bond restructuring is voluntary and not binding on all bondholders. As such, it does not appear to be likely that the restructuring will trigger payments under existing CDS contracts. In addition, it is important to note that the restructuring proposal is not yet at the stage at which the ISDA Determinations Committee would be likely to accept a request to determine whether a credit event has occurred.”
By this logic a haircut of 100% will not be deemed a credit event as long as it is voluntary. Sovereign CDS will only be triggered if participation is compulsory and binding on all holders. It is likely that the 50% figure is as much as bondholders were prepared to stomach on a “voluntary” basis. The net notional amount of Greek CDS outstanding is only $3.7 billion. According to ISDA, firms’ net exposures are partially offset by the recovery value of underlying obligations. For example, if the CDS auction showed the recovery value of debt to be (hypothetically) 50%, the maximum aggregate amount payable would, in Greece’s case, be 50% of $3.7bn: $1.85bn. On average, 70 per cent of derivatives exposure is collateralized.
The aim of the haircut is to achieve €100 billion of burden-sharing with the private sector to get the country’s debt:GDP ratio to 120% by 2020. Under the arrangement outstanding bonds face a NPV reduction of nearly 70%. The yield on Greek bonds due in October 2022 fell 117 basis points to 2,415 basis points on the news.