(This story originally appeared on IFRe.com, a Thomson Reuters publication)
By Christopher Whittall
LONDON, May 30 (IFR) - Two years on from provoking uproar in the midst of the largest sovereign debt restructuring in history, credit default swaps referencing Greek bonds are once again changing hands in what amounts to a remarkable comeback for the much-maligned instrument.
Few mourned the disappearance of Greek CDS from financial markets when they triggered in March 2012 after the Hellenic Republic hacked EUR100bn off its debt pile. Politicians attacked Greek CDS for supposedly pouring oil on the fire in peripheral Europe, while investors worried the contracts were not worth the paper they were written on as flaws in the instrument were exposed.
But while Greek CDS has begun trading once again, the instrument has returned with more of a whimper than a bang, largely thanks to an EU ban on traders taking "speculative positions" in sovereign debt. Even though the derivatives industry has overhauled sovereign CDS documentation and plans to launch a new contract in September to bolster the instrument's battered reputation, the ban has reduced the sovereign CDS market to a shadow of its former self.
"More or less all the dealers are quoting Greek CDS, but it's never going to be what it was in the glory days given the EU ban," said Paul McNamara, an emerging markets portfolio manager at GAM. "The European CDS market is just about dead. CDS isn't even a good gauge of Greek credit risk anymore - it's a curiosity more than anything else."
Greece's blow-out return to primary markets in April with a EUR3bn five-year bond - which was swamped with over EUR20bn of orders despite yielding only 4.95% - paved the way for CDS to begin trading again.
Tickets remain small at USD3m, in line with the size of bond blocks quoted in the market, while the bid-offer spread is wide at around 20bp. Markit said five-year Greek CDS was being quoted at 17 points upfront on Thursday, meaning it would cost USD1.7m to buy protection against USD10m of notional.
"There are some Greek quotes, but the market remains tiny," said Elie El Hayek, global head of rates at HSBC. "CDS tends to trade when countries have problems, and at the moment there is not much going on in Europe."
When Greek CDS triggered two years ago, there was USD3.2bn of net notional outstanding in the market. Today, Greece does not even make it into the DTCC's top 1,000 CDS contracts. It is still early days, but no one is predicting a quick rebound in volumes. In general, European sovereign CDS activity has cratered since an EU ban against outright short positions came into force in November 2012.
The net notional outstanding of CDS on all 28 EU member states has almost halved from USD150bn at the height of the eurozone crisis in September 2011 to USD82bn currently. Meanwhile, trading in the iTraxx Sovx Western Europe index has virtually dried up.
Instead, speculative activity has shifted to government bond futures, which are exempted from the EU ban. The Italian BTP contract has become the weapon of choice for hedge funds taking a negative view on peripheral Europe. A recent study from ISDA highlighted that average daily volume in long-term Italian government bond futures has increased by 101% since the CDS ban came into force.
"The BTP future has become the generic eurozone periphery hedge - just as Spain, Italy or Greek CDS were once the peripheral debt proxy," said McNamara.
As a result of the EU ban, efforts to revive sovereign CDS trading are likely to continue to fall flat with the buyside. As well as ISDA's project to mend flaws in the contract - which would have left Greek protection holders severely out of pocket but for a fluke happy outcome in the CDS auction - the IntercontinentalExchange began clearing sovereign CDS contracts referencing Italy, Ireland, Portugal and Spain last month. (Reporting By Christopher Whittall, editing by Matthew Davies)