Greece deal triggers $3 billion in default swaps, ISDA says

March 9 (Bloomberg) -- Greece’s use of collective action clauses forcing investors to take losses under the nation’s debt restructuring will trigger payouts on $3 billion of default insurance, the International Swaps & Derivatives Association said.

A total 4,323 credit-default swap contracts can now be settled after ISDA’s determinations committee ruled the use of CACs is a restructuring credit event. Before the ruling, Greek swaps rose to a record $7.68 million in advance and $100,000 annually to insure $10 million of debt for five years.

The decision was unanimous, New York-based ISDA said today in a statement distributed by Business Wire. An auction to set the size of the payouts will be held on March 19.

A settlement is poised to bolster confidence in the $257 billion government-debt insurance market after Greece’s restructuring tested the viability of default swaps as a hedge. Greece reached its target for participation in the debt restructuring after using CACs to force the hand of holdouts, with investors in 95.7 percent of the bonds taking part.

Policy makers including former European Central Bank President Jean-Claude Trichet opposed payouts on Greek credit- default swaps on concern traders would be encouraged to bet against failing nations and worsen the region’s debt crisis.

‘Best Instrument’

“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.”

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,” he wrote.

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.

Daisy Chain

“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.”

Credit-default swaps on Greece now 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 settlement of $5.2 billion on Lehman Brothers Holdings Inc. in 2008.

While there were concerns at that 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.

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.

Restructuring

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, Pacific Investment Management Co. and Morgan Stanley, rules after a request is made by a market participant.

In a restructuring credit event investors have the right to choose whether to settle their default swap contracts.

Auctions will set a recovery value on the bonds and swaps sellers will pay buyers the difference between that and the face value of the debt.

Bloomberg News

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