The use of collective action clauses in Greek bonds, as part of the country’s sovereign restructuring, seems set to trigger credit default swaps. For the $3.2bn of net notional still outstanding on the contracts, it’s been a long road to a credit event.
In Part 1, FT Alphaville discussed how the next point of focus will be the performance of the auction that will determine the payout to protection buyers of the contracts.
It turns out that it won’t be easy to ensure that the auction is ‘fair’ from the perspective of a Greek bond holder, where said bonds follow Greek law.
English or Irish duct tape?
The issue is one of ensuring that there are deliverables for a credit event auction will exchange hands at a level that is representative of the losses experienced by bondholders.
One possibility is to use English law bonds, since the bond swap for those isn’t going to occur until April. The reason for that is those bonds already have CACs, but the notice period for a vote is three weeks. So that will just take more time.
However, those bonds trade 7-10 percentage points higher than most Greek law bonds, because of the chance that minimum amount of votes needed to enforce a restructuring with the CAC won’t be reached, hence the bonds might remain untouched. The reason that that might happen is a lot of these bonds are held by investors outside Europe, hence said investors are somewhat less liable to be strong-armed by European politicians. Who knows though? The extra points are from the vague possibility that those bonds will remain unswapped, unCAC-ed and still perform.
So if the English law bonds are delivered in the auction, then the Greek law bondholders will be short-changed by something in the region of 7-10 points ish (though a hell of a lot could happen to this premium on the English law bonds between now and an auction).
The other thing that could happen is that, as happened with Anglo Irish, some bonds are deliberately set to the side to be used in the auction. Rather than being part of the first swap + CAC vote, a couple of big, liquid issues are left out there, untouched expressly to ensure a fair CDS settlement.
We had been thinking that that would be possible. Whether it was likely with all the politics around the whole thing is a different question… But then we saw this bit of excellent reportage by Matina Stevis and Alkman Granitsas at Dow Jones via the WSJ:
Contrary to usual practice, Greek CACs will apply to the stock of debt, rather than bond issue by bond issue.
This means that creditors who may have built strong positions in a specific Greek bond issue by buying it up in the secondary market with an eye to blocking the restructuring process will likely be unable to do that.
“In order for the selected titles [bonds] to be altered… the necessary participation in the process is at least one half of the entire outstanding principal capital of all selected titles… Further, for the alteration of all the selected titles… it is necessary [to have] a super-majority of two thirds,” the bill says.
Sounds like the legislation will suck up all the (old) Greek law bonds, leaving only English law bonds for an auction.
CDS soul searching
When it looked like Greece CDS might not trigger because of the voluntary nature of the bond swap, there was a lot of discussion over the value of the derivative if it failed to pay out in something that looked an awful lot like a default.
Now that a credit event is a near certain (barring an inordinately high participation rate in the PSI making it unnecessary to use the CAC), the focus must surely shift to the auction that determines payouts. If it settles in such a way that the remaining CDS protection buyers are not compensated for their losses, the debate may well resurface.
As for the knock-on effects that will have on other sovereign CDS and bonds… well, imagine this… The perception that CDS do not hedge sovereign holdings effectively results in it being even harder for other peripheral countries to issue debt. As a result of which, they require further bailouts. Oh, and we think it might knock confidence in the new quasi-CDS that the EFSF was planning on issuing, you know, to help peripherals access the bond markets at more affordable rates.
But the skies are grey, and we’re feeling a bit doomy. Maybe everything will be just fine.