Opposition to payouts on Greek credit-default swaps from European Union policy makers is softening as disputes over a voluntary debt exchange threaten to push the nation into default.
Any agreement between the Greek government and the Washington-based Institute of International Finance on debt writedowns will only bind 50 percent of investors in the 206 billion euros ($271 billion) of notes being negotiated, Barclays Capital estimates. Hedge funds may resist a deal, seeking to get paid in full or compensated from insurance contracts.
Greece must repay 14.5 billion euros of bonds in March and an agreement that triggers as much as $3.2 billion of default insurance may be necessary unless all bondholders approve, said Marco Buti, head of the European Commission’s economics division. EU Economic and Monetary Affairs Commissioner Olli Rehn said today in Davos that a deal is “very close.”
“Politicians seem less concerned than before about CDS triggers,” said Michael Hampden-Turner, a credit strategist at Citigroup Inc. in London. “Having a payout on Greek CDS is probably better than the alternative: a loss in market faith of the product’s ability to provide a hedge against sovereign risk.”
Officials, including former European Central Bank President Jean-Claude Trichet, have insisted that a swaps trigger was unacceptable because traders would be encouraged to bet against indebted nations and worsen the crisis.
Analysts at New York-based JPMorgan Chase & Co. and Citigroup say a Greek payout may actually bolster confidence in the $232 billion sovereign insurance market and also help boost the government bond market.
Greek Prime Minister Lucas Papademos resumes talks in Athens today with Charles Dallara, the IIF’s managing director, after “some progress” was made at a meeting last night.
Default swaps insuring $10 million of Greek debt for five years cost $6.3 million in advance and $100,000 annually, according to CMA. That implies an 83 percent chance the government will default in that time, assuming investors recover 22 percent of their holdings.
Greek 10-year bonds fell today, pushing the yield on the securities up four basis points to 33.94 percent. The price slipped to 20.82 percent of face value. Two-year notes advanced, with the price climbing to 22.67 and the yield dropping 2,886 basis points to 171 percent.
Greece said it may impose losses on investors who fail to support the debt restructuring by adding a so-called collective action clause, or CAC, into its bond documentation. That would force holdouts to accept the same terms as the majority.
Use of CACs would trigger a restructuring credit event and a payout of default swaps, according to rules from the International Swaps & Derivatives Association.
Credit events can be caused by a reduction in principal or interest, postponement or deferral of payments, or a change in the ranking or currency of obligations. Any of these must result from a deterioration in creditworthiness, apply to multiple investors and be binding for all holders. ISDA’s determinations committee rules whether swaps can be triggered.
Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.
“A CAC is looking increasingly like the best option,” Citigroup’s Hampden-Turner said. “That route seems to tick a lot of boxes: they don’t have a bond default, the official sector gets treated differently than the private sector, and everybody has to participate in the exchange without anybody getting paid in full.”
While the ECB oppose any involuntary restructuring of Greek debt, policy makers such as Dutch Finance Minister Jan Kees de Jager say they aren’t against a credit event.
The softer stance signals Greece is unlikely to get sufficient participation in a voluntary bond swap to make its debt burden sustainable. Negotiations have focused on the coupon bondholders will accept on new debt with Europe’s finance ministers pressing investors to accept bigger losses after the IIF made what they described as their “maximum” offer.
“It would be welcome if the ECB is no longer blocking the only sensible route for Greece to resurrect itself,” said Georg Grodzki, the London-based head of credit research at Legal & General Plc, which manages $550 billion of assets.
Hedge funds in New York and London are trying to profit from trading Greek government bonds as banks brace for losses from a debt swap.
Saba Capital Management LP, founded by former Deutsche Bank AG credit trader Boaz Weinstein, York Capital Management LP, the $14 billion fund started by Jamie Dinan, and London-based CapeView Capital LLP are among managers that now hold Greek bonds, according to people with knowledge of the transactions.
Officials are now more concerned about preventing a disorderly Greek default that might threaten indebted European nations such as Italy, Portugal and Spain. An orderly credit event would be positive for the market, according to Saul Doctor, a London-based credit strategist at JPMorgan.
“There’s less emphasis on the perils of triggering CDS,” said Barnaby Martin, a European credit strategist at Bank of America Merrill Lynch in London. “It’s now about making sure Greece’s debt is sustainable.”
Portuguese bond yields widened this month on speculation the indebted nation may follow Greece in seeking losses from private investors. The country’s 10-year bonds yield 15.16 percent. Two-year note yields are higher at 16.8 percent.
The upfront cost of insuring Portugal’s debt jumped 6 percentage points since Jan. 13 to a record 39 percent, according to CMA, meaning it costs $3.9 million in advance and $100,000 annually to insure $10 million of the country’s debt for five years.
Outstanding contracts on Portugal have tumbled to $5 billion from about $8 billion last year, according to data from Depository Trust & Clearing Corp., covering 2 percent of the nation’s debt.
“Contagion has already happened to a large extent and officials are probably not as scared of triggering CDS as they were six months ago,” said Cagdas Aksu, a European rates strategist at Barclays Capital in London. “If there is any way to avoid the CDS trigger, they will of course prefer it, but the chances of this has become low at this stage.”