Europe still has a chance of safely shepherding Greece through an increasingly inevitable default and could restore faith that investors can protect themselves against governments not repaying debt.
Time is fast running out. Greece cannot pay a 14.5 billion euro ($18.5 billion) bond falling due on March 20, and a deal with bondholders needs to come well before that, because the paperwork alone takes at least six weeks.
Many in markets would welcome an orderly default, whereby Greece’s lenders allowed it to renege on its commitments to repay, provided it avoids a far more painful hard default, which could herald the end of the single currency.
“People often ask if Greece is going to default which … is a misnomer because Greece is (already) defaulting,» said Richard McGuire, a strategist at Dutch bank Rabobank.
A managed default would trigger a pay-out of Credit Default Swaps (CDS), which offer insurance against default of a company or country, and would restore trust in these financial tools that are crucial for investors to hedge against risk.
“Regulators across the world would breathe a sigh of relief that hedges many of their regulated financial entities have on their European positions are effective,» said one market participant, asking not to be named.
The future of the market for sovereign CDS has been put in doubt because politicians were initially adamant banks and other investors should voluntarily swap their Greek bonds for new ones worth half the original value. Such a voluntary agreement would likely leave investors unable to claim the protection offered by CDS.
But Greece is now openly threatening to force unwilling investors into the deal, bringing an element of coercion into the negotiations that will likely be sufficient to trigger a CDS payout.
Lehman Brothers triggered widespread market panic on fears that up to $400 billion in CDS would be payable when it collapsed in 2008. But the amount that was actually paid out was relatively small, and is smaller for Greece.
The maximum that could change hands from a Greek default is $3.34 billion, according to the Depository Trust