By Daniel Bases
NEW YORK, March 9 Greece's debt swap deal will trigger the payout of insurance protection on the country's bonds because of legislation that forced all private creditors to take losses, an industry group said on Friday.
The International Swaps and Derivatives Association said the decision by its EMEA Determinations Commission to declare a so-called credit event was unanimous.
The actual payout to creditors is likely to be less than the maximum of $3.16 billion of net outstanding Greek credit default swap contracts because bondholders are not losing all of their original investment.
"We do not foresee a significant impact from the Greek credit event on the financial markets. The amounts of exposure are relatively small," Robert Pickel, chief executive officer of ISDA, said in a conference call with reporters. "They are known and they are very public, and most of this exposure (in the overall CDS market) is collateralized."
Markets showed little reaction to the widely expected decision. The euro edged lower against the dollar while U.S. Treasury prices pared losses in thin trading conditions after the announcement.
Approximately 93 percent of credit default swap contracts, are collateralized, meaning investors and dealers hold collateral on their books to cover potential payouts. Credit default swaps provide protection for an investor who holds an underlying security that suffers from a default or a restructuring.
ISDA said an auction will be held to determining the actual payout amounts on March 19.
ISDA said its decision was based on Greece's use of collective action clauses to amend the law governing terms of government-issued bonds "such that the right of all holders of the Affected Bonds to receive payments has been reduced."
Greece said it would use the newly passed legislation that included the CACs to force private creditors into a bond swap.
The Greek Finance Ministry said creditors voluntarily tendered 85.8 percent of the 177 billion euros ($232.22 billion) in bonds regulated by Greek law.
Holders of another 20 billion euros in foreign law and state enterprise bonds accepted the offer. That is equivalent to 69 percent of the total of those bonds.
The use of the collective action clauses should boost participation to an estimated 95.7 percent.
The final offer deadline for bonds under foreign law and those issued by Greek public firms under state guarantees has been extended to March 23. Bondholders who have already submitted tenders will not be allowed to change their response.
A committee of private investors represented by the Institute of International Finance, a banking lobby, negotiated the voluntary debt swap last year in order to cut Greece's debt from a towering 160 percent of its annual economic output now to a somewhat more manageable 120 percent by 2020.
The structure of the swap, which originally had been set out to be voluntary in an effort to avoid a credit event but then resulted in the forced inclusion of all bondholders through the use of the collective action clauses, put a spotlight on investor rights. It raises questions over the viability of the CDS market overall.
Enforcing the contracts is paramount, said ISDA's Pickel.
"I think it is fair to say that when people engage in sovereign trading they know they are dealing with an entity that has the ability to amend the terms of its obligations," Pickel said.
"I think it would be far more damaging for us to have, not just that potential uncertainty, but also to have uncertainty as it relates to the interpretation of the contract. So that is why we think it is very important for us to follow this through even though it has been a long process of getting to the determination of today," he said.
According to the Depository Trust and Clearing Corporation, since it began tracking credit default swaps in 2003, the only other sovereign credit event to trigger a payout was Ecuador in January 2009 with a net notional amount of $473 million.
The DTCC, which provides clearing and settlement operations for financial transactions, says net notional amount of sovereign CDS contracts as of March 2 was $236.5 billion.
The announcement of the decision was not without its own drama. About 30 minutes prior to official confirmation of the credit event ISDA inexplicably posted and then took down its press release, sowing confusion in the market over what its final, albeit expected, decision would be.