Tuesday, February 28, 2012

Today's Major Market Move: PIIGS Combined CDS Surge 163% in February

One outstanding issue from the most recent Greek bailout involves Greek credit default swaps and how (or even if) they will pay out. The EU and the international body that governs swaps, the International Swaps and Derivatives Association (know affectionately as the ISDA), have become legal contortionists of the first degree in their quest to avoid the triggering of a credit event. I'm sure the fiscal and political authorities fear an AIG type event in which a company has so much CDS exposure (that ended up _not_ "netting-out" as many financial firms claim their CDS exposure does) that it ends up taking that company completely down (of course AIG ended up surviving thanks to massive intervention by the U.S. Government and the Fed) and threatens to send major reverberations through the economy.

Bloomberg, where we usually get our Greek CDS pricing info, hasn't provided a price on standalone Greek CDS since September of last year. So the next best thing we can do is observe the price for the combined PIIGS CDS (there's no indication of the duration), otherwise known as the .GIPSI. The .GIPSI has gone from just under 1800 at the beginning of the month to over 4500 as of today's close, for a gain of 163%. To give an idea of how much an outlier this is in the CDS complex, only 2 other sovereign CDS have risen this month, the Argentinian 5 Year (up 2.9%) and the French 5 Year (up 1.7%). Here's the list of the worst performing CDS over the past month:

Click here to go to the live table.
Now this time around we may actually see a Greek credit event officially acknowledged. This is because financial firms and investors have whittled down their Greek CDS exposure to under 4 billion Euros, a paltry amount when discussing global credit markets. Here's some more color from Felix Simon at Reuters:
... it’s important to understand the big picture. Greece has a lot of private-sector debt; most of it is held by banks. There is a small amount of sovereign CDS outstanding, which references that Greek debt. To give you an idea of the orders of magnitude here, we’re talking about roughly €200 billion in Greek bonds, and less than €4 billion in net CDS exposure. Even if all of the net CDS exposure was held by bank creditors, it wouldn’t remotely offset the write-down they’re going to have to take on their bonds.
In reality, the banks have de minimis net CDS exposure. They might trade the CDS, and have either a long or a short position on their trading books at any given time, but they’re not using the CDS to hedge their bonds.
Later in that same article he tries to justify how the financial authorities are using technicalities to avoid CDS sellers paying out on bonds that aren't being paid back at par. He talks about how bonds are fungible yet we are seeing subordination-after-the-fact (where the ECB isn't taking a loss on their Greek bond holding) as well as collective-action-clauses being put in place after the bonds were issued.

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