Greece Default Swaps Failure to Trigger Casts Doubt on Contracts as Hedge

Bloomberg
October 27, 2011

The European Union’s ability to write down 50 percent of banks’ Greek bond holdings without triggering $3.7 billion in debt insurance contracts threatens to undermine confidence in credit-default swaps as a hedge and force up borrowing costs.

As part of today’s accord aimed at resolving the euro region’s sovereign debt crisis, politicians and central bankers said they “invite Greece, private investors and all parties concerned to develop a voluntary bond exchange” into new securities. If the International Swaps & Derivatives Association agrees the exchange isn’t compulsory, credit-default swaps tied to the nation’s debt shouldn’t pay out.

“It will raise some very serious question marks over the value of CDS contracts,” said Harpreet Parhar, a strategist at Credit Agricole SA in London. “For euro sovereigns in particular, the CDS market is likely to remain wary.”

Politicians and central bankers came to a last-minute agreement after banks, the biggest private holders of Greece’s government bonds, were threatened with a full default on their debt, according to Luxembourg Prime Minister Jean-Claude Juncker. ISDA General Counsel David Geen said his organization considered the agreement to be voluntary, even if there may have been “a lot of arm twisting.”

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