Credit default insurers will not pay out over Greece

Tim Wallace
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GREECE has not defaulted on its debts after all because the government has negotiated a “voluntary” haircut with investors, the International Swaps and Derivatives Association (ISDA) controversially ruled yesterday.

As a result, €3bn (£2.5bn) in insurance contracts taken out against the risk of Greece defaulting will not be paid out, even though bondholders face heavy losses following a 50 per cent writedown.

The decision has been criticised by some as making a mockery of credit default swaps on sovereign debt. These critics believe that their value has now been permanently undermined.

ISDA’s voting committee unanimously decided a “credit event” has not occurred because investors have not been legally forced to take losses on their bonds – even though ratings agency Standard and Poor’s classes the country as being in a “selective default.”

If the default was deemed “voluntary,” it was hoped investors would not put bets on governments defaulting. Such a move could have pushed them into ever deeper trouble, raising the chance of a default occurring.

However, ISDA acknowledged “the situation in Greece is still evolving” and a credit event could occur at a later date.

“The ultimate result of the exchange between private market holders and EU authorities are not yet known,” said Bill Gross from Pimco, the bond fund that sits on ISDA’s voting committee.

“We expect the next few days to ultimately bring the committee back for one final vote.”

As part of the Greek bailout – negotiated by technocratic Greek Prime Minister Lucas Papademos – private investors are expected to swap their bonds in the coming weeks into longer-term bonds of lower value.

If some investors refuse to take part in this swap, and so are forced to take losses by the Greek government through collective action clauses, they will be able to apply again to ISDA to consider whether or not a credit event has occurred.

The debt swap itself is vital because Greece needs to reduce its debts if it is to avoid going bankrupt.

Greece will only receive the next tranche of its bailout funds from other Eurozone countries if it does persuade enough investors to take the haircut.

Eurogroup leader Jean-Claude Juncker praised the country yesterday for its efforts in slashing spending, raising taxes and reforming its economy, but stressed that the bailout cash was not guaranteed.

“A successful PSI operation with high participation and a final positive assessment of the complete set of prior actions are necessary conditions both for the disbursements of these EFSF bonds and for the second programme,” he said.

ISDA’s voting committee includes banks which are involved in that PSI debt swap, as well as those which have bought and sold credit default swap insurance on Greek debt. Critics argue this means the panel is not entirely impartial.

It is comprised of 10 banks, including Deutsche Bank, BNP Paribas and JP Morgan, and five asset managers including BlueMountain Capital and Elliott Management Corporation. A supermajority of 12 or more members is required to declare a credit event has taken place.