From a purely academic perspective, FT Alphaville does care of course.
But in a big picture/markets sort of way — we really don’t. All this talk of what will trigger Greek CDS or whether a voluntary roll-over will constitute a default or not — won’t matter much, when push comes to shove. True, the European Central Bank has threatened not to accept Greek government bonds as collateral if they’re classified as a selective default. But no one really believes them.
A point aptly made by Danske Bank’ senior economist Frank Øland Hansen on Wednesday:
Since the smaller investors are free not to roll over their debt, they do not face any losses and cannot claim that it is a credit event. The major investors will not claim that it is a credit event either as they simply purchase new bonds (voluntarily) and no imminent loss in banking books has resulted from this move.
The rating agencies might nevertheless cry fault and downgrade Greece to default. Rating agencies are also likely to downgrade other peripheral countries in the event of ‘voluntary’ private sector participation in a rescue package for Greece.
But it is ISDA (and the wording of the CDS contract) that determines whether it is a credit event, which would trigger payment on the CDS contracts. Given that the existing maturities simply mature and the purchase of new bonds will be discretionary (there will not be a bond exchange binding all holders), it is our understanding that it would not be a credit event.
In any case, the CDS exposure does not seem to be very big relative to the Greek sovereign debt market. According to data from the Depository Trust & Clearing Corporation (DTCC), the gross issuance is USD77.5bn while the net notional (maximum bank exposure) registered by DTCC is just USD5.5bn, or less than 2% of outstanding debt. In addition to this, there is an unknown but possibly small amount of contracts not registered by DTCC. The exposure could potentially cause problems for some banks, but it does not seem to be a threat to the system. The CDS exposure is negligible compared with the CDS exposure on subprime loans that fuelled the financial crisis.
And as for the ECB and the big collateral question…
… we have previously seen the ECB show substantial flexibility with its collateral rules. Indeed, in January 2010, the ECB said that it would not soften its collateral policy for the sake of a single country, but a few months later it made a U-turn and did exactly that and eased its collateral rules to accommodate Greece’s needs.
And keep in mind that in March 2011 the ECB announced that “the Governing Council of the European Central Bank (ECB) has decided to suspend the application of the minimum credit rating threshold in the collateral eligibility requirements for the purposes of the Eurosystem’s credit operations in the case of marketable debt instruments issued or guaranteed by the Irish government. The suspension applies to all outstanding and new marketable debt instruments. It will be maintained until further notice”. In other words, the ECB can and will suspend the application of the minimum credit rating threshold when needed.
Despite the hard rhetoric today, we therefore think that the ECB will make another U-turn if necessary. Indeed, we believe that the ECB will take all euro area sovereign bonds as collateral as long as there is a euro area, though it might ask for a substantial haircut. So if rating agencies downgrade Greece to default, we think that the ECB will find a way to alter its collateral requirements to allow for this. If not, then other funding sources will most likely be provided from the European System of Central Banks (ESCB) to Greek banks and possibly also other holders of large amounts of Greek bonds. In conclusion, a downgrade from rating agencies will probably result in further spread widening for peripheral countries, but it will not be allowed to result in a chaotic situation where the Greek banks are left on their own.
Or, of course, the rating agencies will provide a face-saving out with some linguistic gymnastics.
One other thing — there’s been some suggestion that the eurosystem’s central banks (notably, that of Greece) could start doing their own-brand of Irish-style Emergency Liquidity Assistance, as another way for the ECB to save face should Greek bonds be slapped with that ‘D’ or ‘SD’ rating.
In other words, where there’s a eurozone will, there’s a eurozone way.