Payday for Ukraine Default Swap Holders as Credit Event Looms

Updated on
  • ISDA to reconvene Wednesday to assess if moratorium took place
  • Ukraine has $500 million bond coming due on Wednesday

When Ukraine fails to pay its $500 million bond due Wednesday, a few investors at least will probably breathe a sigh of relief.

The Finance Ministry said last month that it would impose a “temporary suspension of payments” to allow it to complete an $18 billion debt restructuring. The move is likely to trigger a so-called credit event -- which means payday for the holders of insurance contracts known as credit-default swaps.

The deferment, in the language of the bond markets, pushes Ukraine into technical default and risks driving its credit rating to the lowest D level. Such purgatory should end with the deal being signed with the remaining bondholders to write down 20 percent of the face value of its debt by earlier December, or so the plan goes. The bonds maturing this week climbed 0.43 cent to 78.15 cents on the dollar on Tuesday, close to the highest level this year.

The following are issues arising from credit events and what may happen next:

Q: What is a credit event?
A: A sovereign credit event is any action that results in a country defaulting on a debt payment. These include failure to pay by a due date, announcing a moratorium or pushing through a restructuring that changes the debt terms in a way that forces all bondholders to participate, according to the International Swaps & Derivatives Association, the trade group that determines whether an event occurred.

Q: How is it triggered?
A: A CDS holder or someone representing them must ask ISDA to determine whether the event has taken place.

Q: Has a credit event already taken place for Ukraine?
A: No request has been posted on ISDA’s website seeking a ruling on whether an event has occurred. A request dated Sept. 18 asked whether a potential moratorium took place after the Finance Ministry signaled a suspension last month. ISDA says it will meet on Wednesday "to allow further time to collate information" after an initial discussion on Tuesday. Under ISDA rules, a yes-vote would allow holders of CDS contracts expiring Sept. 20 to receive a payout in the case of a future credit event.

Q: When will a CDS payout be made?
A: Payouts are made after an ISDA panel of investors and CDS dealers rule the event occurred. Payments are calculated by deducting the estimated recovery value on the bonds from the face amount of the CDS contracts. The recovery value is usually calculated at an auction held by ISDA.

Q: How did it work for other countries
A: When Greece overhauled its debt in 2012, ISDA declared a credit event after authorities used so-called collective action clauses to force all holders to accept an exchange offer. A failure-to-pay event was called on Argentina in September last year after the government missed a deadline to pay $539 million in interest.

Q: Who will be paid?
A: Not all bondholders hold CDS and the volume of outstanding contracts has dropped by almost half in the past year as the price of insuring Ukraine’s debt against default surged. The net notional value of about 2,500 default-swap contracts outstanding on Ukraine was about $396 million as of Sept. 11, according to the Depository Trust & Clearing Co., which maintains trading data.

Q: How will this affect Ukraine’s debt rating?
A: While a credit event won’t automatically lead to a downgrade of the country’s debt, rating agencies may follow with a cut, according to Alexander Kudrin, an analyst Sberbank CIB. Ukraine’s credit grade will rebound to "single-B category" after the restructuring is completed, he said.
 
Ukraine is rated Ca, two steps above default, at Moody’s Investors Service, and has an equivalent grade at Standard & Poor’s, while Fitch Ratings ranks it one step lower. S&P said on Aug. 28 that a default on the government’s foreign-currency debt is a "virtual certainty" since it classifies both a bond exchange and payment suspension as a default. 

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