October 26, 2011 / 12:46 PM / 9 years ago

Will they, won't they: Greek CDS trigger in question

(The following article was published IFRe.com, a Thomson Reuters publication)

By Christopher Whittall

LONDON, Oct 26 (IFR) - Markets analysts are in disagreement over whether the latest plans to restructure Greek debt would trigger a credit event for credit default swaps referencing the sovereign.

Media reports have cited proposals as high as a 60% haircut on Greek government bonds - far higher than in previous negotiations - but indicated any participation in such an exchange would be voluntary.

Following the letter of the law, this should not trigger CDS, but some analysts have expressed doubt over whether a haircut of this size would work on a non-mandatory basis, as it would be unlikely to attract enough bondholder uptake to make it viable.

“It all depends on the facts, but on the straight reading of the clause, if this doesn’t bind all of a reference obligation’s bondholders then it’s not a restructuring credit event,” said Edmund Parker global co-head of the derivatives and structured products practice at Mayer Brown.

“It’s clear that they’re trying to make this voluntary so it’s not a credit event, which of course calls into question the value of purchasing Greek sovereign CDS,” he added.

Pawan Wadhwa, head of European rates strategy at JP Morgan, wrote in a note to clients that “there is a high probability (2 in 3) that policymakers will be able to restructure Greek debt voluntarily, thereby avoiding a CDS trigger”.

Wadhwa highlighted Greek debt trading at 40 cents on the euro beyond two years, as well as good take-up for voluntary sovereign debt restructurings in the past as reasons to suggest that a “soft” restructuring could work.

In an indication of the uncertainty surrounding the issue, though, Saul Doctor - a credit derivatives strategist also with JP Morgan - contradicted his colleague’s view.

“I think the chance of a CDS trigger is quite high. When there was a 20% haircut on the table you could argue most people would accept it. But I think at 60% the number of holdouts will be larger, and they will have to find some way of dealing with the holdouts that will likely result in a CDS credit event,” said Saul Doctor, credit derivatives strategist at JP Morgan.

“Whenever you look at past emerging markets restructurings, the ones than were done on a voluntary basis were less than 30% haircuts - you’re talking something much bigger than that,” he added.

This view was supported by Antonio Garcia Pascual, an analyst with Barclays Capital, who wrote in a note to clients: “there is little doubt that a large notional haircut of [around] 50-60% would be considered a credit event.”

European politicians have signalled they are keen to avoid triggering Greek CDS in any debt restructuring, which has led many to call into question the value of the product.

Some market participants have questioned the logic behind avoiding a CDS trigger, however, pointing out the net notional of Greek CDS has dwindled over the past 18 months to USD3.7bn and so a trigger is unlikely to cause major market issues.

Bank loan and counterparty credit desks - which use Greek CDS for hedging exposure to the sovereign - have previously expressed concern over the repercussions of politicians deliberately seeking to avoid triggering CDS when restructuring Greece’s debt. (Reporting by Christopher Whittal)

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