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ECB Bond Exchange Spurs Likelihood of Greek Default Swap Payout

An EU flag Flies At The Foot Of The Acropolis Hill
Credit-default swaps insuring Greek government debt may pay out because a proposed bond exchange by the European Central Bank paves the way for losses to be imposed on private investors. Photographer: Kostas Tsironis/Bloomberg

Credit-default swaps insuring Greek government debt may pay out because a proposed bond exchange by the European Central Bank paves the way for losses to be imposed on private investors.

Greece will introduce legislation next week that may allow so-called collective action clauses that force bondholders to accept debt writedowns, Naftemporiki reported. The ECB’s new bonds will have identical structure and nominal value to their current Greek notes, though they will be exempt from CACs, three euro-area officials said.

“The probability of triggering CDS has increased because the ECB has protected itself,” said Padhraic Garvey, head of developed-market debt at ING Groep NV in Amsterdam, who says the probability of a credit event is still low.

As much as $3.2 billion of default insurance may be trigged if the CACs are used because all investors would be bound by a majority agreement to accept a proposed debt restructuring. ECB officials previously rejected the possibility of a credit event triggering swaps, arguing it would encourage traders to bet against indebted nations and worsen the crisis.

The introduction of the clauses doesn’t in itself trigger default swaps, though using them does, according to rules of the International Swaps & Derivatives Association. David Geen, ISDA’s general counsel, declined further comment.

Credit Events

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 on all holders. ISDA’s determinations committee rules whether swaps can be triggered.

“If indeed this maneuver is intended to protect the ECB from forced losses, then the risk of a voluntary restructuring morphing into a coercive one has arguably increased significantly,” Chris Walker, an analyst at UBS AG in London, wrote in a note. “If a coercive default does indeed eventually take place then a CDS event seems very likely with all the negative consequences for risk appetite that may bring.”

The yield on the Greek 2022 bond today climbed 60 basis points to 33.98 percent, with the price at 20.825 percent of face value. The price of the 4.3 percent note due March 20 declined to 39.05 percent of face amount, from 42 yesterday.

Default swaps insuring $10 million of Greek debt for five years cost $6.8 million in advance and $100,000 annually, according to CMA. That implies an 89 percent chance the government will default in that time.

A total of 4,183 contracts insuring a net $3.2 billion of Greek debt were outstanding as of Feb. 10, according to the Depository Trust & Clearing Corp., which runs a central registry for the market. 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.

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