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Greek Default Swap Volumes at Record Low Before Bond Exchange

Greek Finance Minister Evangelos Venizelos
Greek Finance Minister Evangelos Venizelos has said he’s not concerned whether the exchange triggers default swaps. Photographer: Kostas Tsironis/Bloomberg

Investors cut Greek credit-default swap trades ahead of today’s debt exchange, pushing the amount of bonds insured to a record low $3.16 billion.

That’s down from a net $5.6 billion of securities protected last year, according to the Depository Trust & Clearing Corp, and compares with a swaps settlement of about $5.2 billion on Lehman Brothers Holdings Inc. in 2008. Five-year Greek contracts now signal a 97 percent chance of default, CMA data show.

Investors who bought debt insurance at lower levels may prefer to book profits now, rather than take their chances on a credit event and auction settlement, according to Harpreet Parhar, a strategist at Credit Agricole SA in London. Greece has said it may use collective action clauses, or CACs, to force bondholders to write down their holdings, and that would trigger payouts on credit-default swaps, according to rules of the International Swaps & Derivatives Association.

“It looks as if CACs are likely to be triggered and therefore the CDS, but it’s still not 100 percent certain,” said Parhar. “If you’re also worried about auction dynamics, it makes sense to close out positions.”

Greece retroactively inserted collective action clauses into bond documentation last month and may use them if the portion of investors who volunteer for the exchange falls short of its target. The addition of CACs didn’t trigger default swaps, ISDA ruled last week, though use of them would.

Against Triggering

Investors are unsure whether Greece will invoke the clauses because officials including former European Central Bank President Jean-Claude Trichet have insisted against triggering default swaps, arguing that traders will be encouraged to bet against failing nations and worsen Europe’s debt crisis. Greek Finance Minister Evangelos Venizelos has said he’s not concerned whether the exchange triggers default swaps.

“If we can avoid the triggering of CDSs this is the best solution,” Venizelos said March 5. “With a near universal participation it’s not necessary to activate CACs. But this clause exists in our legal order and we are ready to implement the legislation if necessary.”

The exchange, known as private-sector involvement or PSI, would wipe 100 billion euros off more than 200 billion euros of privately held debt if all investors participate. Even so, Greece may struggle to reduce its national debt to 120 percent of gross domestic product, the level it committed to in return for a 130 billion-euro international bailout. Greece’s debt to GDP ratio was 160 percent last year.

Participation Rate

“Even if they get 100 percent participation they’re not at a sustainable debt level, so anything below that is not likely to give the debt relief that’s required,” said Elisabeth Afseth, a strategist at Investec Bank Plc in London. “We would be very surprised if CACs were not invoked and would also find it surprising if this was the last restructuring we see in Greece.”

Greece may not get sufficient participation because some investors are refusing to volunteer. Patrick Armstrong, managing partner at Armstrong Investment Managers in London, said he’s holding out because of the “miniscule” chance his bond maturing March 20 will be redeemed at face value.

Armstrong said he’s betting against banks rather than using default swaps on Greece to hedge his holdings, in part because of concern the contracts won’t be triggered. That same concern may be driving the reduction in default swap positions.

“There’s no real incentive to participate,” Armstrong said yesterday in a Bloomberg Television interview. “If I participate, I get the same terms as everyone else who does it voluntarily. If I don’t, most likely I’ll end up with the same terms.”

‘Reduce Exposure’

Traders bought and sold 110 contracts covering a gross $1.7 billion of the country’s debt in the week through March 2, DTCC data show. That’s more than recent weekly trading volumes and brings the total trades outstanding to 4,323, the most since Jan. 13.

“It’s rational for investors to reduce exposure if the effectiveness of the contract depends on political negotiations rather than fundamentals,” said Alberto Gallo, head of European credit strategy at Royal Bank of Scotland Group Plc in London. “You can move to other types of macro hedging.”

It costs a record $7.5 million in advance and $100,000 annually to insure $10 million of Greek debt for five years, according to CMA. 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.

Sellers of default protection may also be unwinding positions to cap their losses if they expect a credit event, Afseth said.

“We’re approaching the final stage of the game as far as Greece is concerned and now it’s down to guessing the outcome of the vote and the resulting reaction of the Greek government,” said Georg Grodzki, head of credit research at Legal & General Plc in London. “Everybody should by now be perfectly positioned according to their expectations on the outcome.”

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