(From the International Financing Review www.ifre.com)
By Christopher Whittall
LONDON, June 11 (IFR) - Credit default swaps on Spain are
unlikely to trigger as a result of the 100 billion euro bail-out
of the country's banking system announced over the weekend,
according to leading derivatives lawyers.
The European Stability Mechanism's senior creditor status
has led to questions over whether a subordination credit event
will be triggered upon Spain receiving loans from the permanent
bailout fund. In contrast to the IMF's preferred creditor
status, which is implicit rather than legally documented, the
ESM's treaty actually specifies its seniority to other creditors
- a clause that some analysts reckon could trigger CDS.
There have been subsequent reports that Spain's emergency
loans may be funneled through the temporary bailout fund, the
EFSF, before the ESM becomes into force in July to avoid a
potential credit event. Such measures may prove unnecessary,
though, as derivatives lawyers have cast doubt on the
possibility of ESM rescue money triggering CDS.
"I can't see any basis on which this would constitute a
subordination credit event as it doesn't change the terms of the
claims held by the other creditors," said Simon Firth, a partner
in the derivatives practice at Linklaters.
"It's actually impossible to have a restructuring credit
event based subordination without something that affects the
rights of existing bondholders. In the absence of some kind of
agreement or change of law, then I don't see anything that will
[do that]," said Firth.
The definition of subordination has two parts, neither of
which would apply to the ESM loans, according to Firth. The
first pertains to companies in liquidation, which does not apply
to sovereign CDS as countries cannot enter insolvency
The second states that existing bondholders won't be
entitled to receive or retain payments with respect to their
claim while the reference entity (Spain) is in default in
respect of its senior obligations (in this case the ESM loans).
"There won't be anything that affects the entitlements of
the existing bondholders to receive or retain payments," said
Firth. "Their entitlement is exactly the same - all you have is
an obligation between the sovereign and some other creditors to
pay off those creditors first. That is not binding on the
PREVIOUS ISDA REJECTION
This is not the first time that questions have been raised
about whether the Spain bailout would trigger sovereign CDS.
The ISDA Determinations Committee rejected a similar inquiry
last year over whether the IMF's seniority status would trigger
CDS after Ireland was bailed out.
One senior sovereign CDS trader said the market was abuzz
with discussion of the issue, but insisted it was too early to
predict what would happen.
"It depends on the ESM loan documentation - not the treaty -
and that hasn't been written yet. If it was formally written in
then it would be cause for the ISDA Determinations Committee to
determine," the trader said.
"You'd assume would try and avoid a trigger.
They did the voluntary Greek PSI to avoid it, even if it didn't
A Spain trigger would constitute the largest CDS credit
event on record. At $14.3 billion net notional outstanding,
according to the DTCC, Spain is far more widely traded than
Greek CDS, for example, which had around $3.2 billion
outstanding when it triggered.
The CDS trader said action in sovereign CDS was carrying on
as normal today. Five-year protection is currently being quoted
at 599bp, having rallied to as low as 555bp earlier this
( www.ifre.com )