Greek failure to pay official lenders could trigger CDS payments, say lawyers

Private holders of Greek default insurance could be in for a payout of over $750 million if Greece defaults on debt owed to the European Central Bank or other public-sector creditors, lawyers said.

Worries of a default have resurfaced as Athens is in a stand-off with its international lenders over its plans to end austerity measures agreed under its 240 billion euro bailout deals.

Greek credit default swaps (CDS) paid out more than a net $3 billion after privately-held debt was restructured in March 2012. Default worries are now focused on debt held by public institutions such as the International Monetary Fund, European Union and ECB.

Investors who hold the relatively small amount of Greek government debt that remains in private hands may still get a payout if they have used CDS to protect themselves – even if Athens defaults only on repayments to the public institutions.

Payouts are made when the International Swaps and Derivatives Association (ISDA), which administers the CDS payment process, declares a “credit event.”

But with no precedent for sovereign default on publicly-held debt triggering CDS payments, many market participants have been uncertain whether their default insurance would pay out in such a scenario.

Lawyers specializing in derivatives say it would. “It doesn’t make any difference whether it’s held by a governmental entity or not,” said Simon Firth, derivatives partner at law firm Linklaters.

“If there is a failure to pay in relation to any borrowings of … Greece, and the failure to pay exceeds a million dollars or its equivalent in the local currency, once any grace period has expired, that’s a credit event.”

However, a special provision introduced soon after the 2012 restructuring says any obligation undertaken by Greece before Feb. 1, 2012 would not trigger CDS payments.

This means any default on IMF repayments due in the next few months is unlikely to trigger CDS, as most of the funds were part of the first of Greece’s two bailouts agreed in 2010. The second bailout was agreed soon after the restructuring and no repayments are due in the near future.

But the repayment to watch is a 3.5 billion euro bond expiring in July which is held by the ECB. As part of a deal to avoid losses on its Greek debt holdings, the ECB swapped in March 2012 the Greek bonds it then held for new ones that were not part of the restructuring.

The other condition for triggering CDS is that the failure to repay debt is not part of a voluntary agreement between Greece and the ECB, EU or IMF. CDS would be triggered only if the debt that is restructured is held by at least four different entities, said David Benton, co-head of the Global International Markets Group at lawyers Allen & Overy.

“If you’ve got a loan or bond that is made just by the ECB for example then if they restructure that’s not going to trigger a credit event,” said Benton, who has advised ISDA on CDS documentation.

Greek CDS payments were triggered in 2012 after the government introduced retroactive collective action clauses to make it easier to force bondholders to take a loss.

ISDA decisions on credit events depend on the assessment of its Determinations Committee, requiring approval by 80 percent of its members – 15 banks or funds active in the CDS market.

Data from the Depository Trust & Clearing Corporation show there are 752 Greek CDS contracts, worth over $2 billion. But on a net basis – buyers of CDS can also be sellers – payments would total $763 million.

Rules introduced in November 2012 mean that only holders of Greek bonds can seek protection via CDS. BlackRock, Loomis Sayles and Carmignac Gestion are among the asset management firms that hold Greek bonds, according to Thomson Reuters eMAXX.

Greek five-year CDS traded at 1,727 basis points on Thursday, meaning it costs $1.7 million annually to insure $10 million of Greek debt, data from Markit showed.

ISDA declined comment.