Thursday, March 8, 2012

Why The Greek Debt Exchange Matters

The International Swaps and Derivatives Association (ISDA) will determine today if a default occurs re: Greece's debt exchange.  The Wall Street Journal: "The Greek government’s intention of invoking "collective action clauses" (CACs) will become clear today, when private bondholders have to indicate whether they want to participate in the deal or not. As part of (another) bailout, private-sector investors (PSI) will have to take a 53.5% loss on their principal and swap their old Greek bonds for new ones. At least 90% of the principal amount currently outstanding has to be tendered for exchange. If the participation rate is between 75% and 90%, Greece would consult the EU on whether to proceed. If it’s less than 75%, the exchange will fail. That could derail the bailout and cause a disorderly default. CACs force all bondholders to take part if a pre-determined majority approves it. Greece has so far resisted the use of CACs for fear of triggering the payout of credit default swap (CDS) contracts. Many analysts feel Greece will not get a high enough participation rate and will have to invoke CACs to push the deal through. If CACs are activated, a debt exchange may no longer be seen as “voluntary” but “coercive,” triggering the payout of CDS contracts. Euro-zone governments have long feared that triggering CDS payouts could create contagion effects throughout the European banking system, similar to those caused by the 2008 global financial crisis. For that reason, officials took pains to come up with a debt restructuring plan for Greece that would be seen as voluntary. But a failure of the CDS to offer protection against blatant adjustments to Greece’s bond contracts could do even more damage, rendering the entire CDS market worthless in the eyes of investors. That in turn could drive investors to dump the bonds of Portugal, Ireland, Italy and Spain, believing that they no longer enjoy the protection of default insurance. Most market participants feel that the impact of a payout of CDS contracts would be limited given the small net exposure of banks that have written these contracts. (A net $3.2 billion of CDS are outstanding on Greek debt according to the latest figures.) Some market participants feel that a CDS trigger may actually benefit peripheral euro zone government bonds by preserving the sanctity of CDS as a useful hedging instrument."