Why the ISDA ‘No’ Vote on Greek CDS Actually Matters




The decision by ISDA’s European determinations committee Thursday to not trigger CDS on Greek debt has been largely shrugged off, mainly because payouts are widely seen as being warranted in the event that Greece forces investors into its restructuring deal. That’s an outcome that many in the markets see as highly likely.

However, the decision still has potential ramifications for other troubled European bond markets.

The determinations committee issued a short statement explaining their decision – which is more than they usually do  – but didn’t provide much information.

However, Dow Jones Newswires Katy Burne tells ‘breaks down the likely rationale for the decision:

The decision turned on a rigidly legalistic definition of when “subordination” occurs.

Subordination is when one set of debt holders is made junior to another group, and falls behind the senior group when trying to collect payments owed by a borrower.

Subordination is defined by ISDA as a “change in the payment priority ranking of any [debt] obligation, causing its subordination.

For holders of CDS to collect, however, investors need to show that explicit subordination has occurred through a “contractual” arrangement, as well as show a more easily determined deterioration in the value of their bonds, in other words that the securities are no longer trading at full face value.

In passing a law to retrofit Greek-law bonds with collective-action clauses, Greece allowed itself to potentially strong-arm all private creditors into a bond exchange, even if they did not agree. The legislation did not say anything about subordinating them.

So when the European Central Bank took new Greek bonds without collective-action clauses in exchange for old bonds, it effectively got preferential treatment because it will not have to face losses, whereas private creditors will when they complete their own debt swap.

However, ISDA’s definitions would not have given the committee flexibility to rule a credit event for CDS because nothing in the bond contracts shows mandatory subordination, experts say.”

The reason all this legal mumbo-jumbo matters is that the ECB has been accumulating debt of other countries. Were any of those countries to undergo a similar restructuring – which some think is a real possibility for Portugal – private bond holders could find themselves pushed aside again.

Here’s Eaton Vance’s Michael Cirami on the big-picture take-away

“This is an important issue. The ECB did their bond swap and … making themselves preferred creditors. This impacts the value of government debt potentially everywhere in the world, and definitely within the euro zone.”

“It should be pretty clear now that when the ECB is buying government debt, if you think the situation is a solvency issue, then the potential haircut as a private investor is going to be bigger than would otherwise be the case. It’s a real issue.” An issue, he says, that is clearly already in play with Portugal’s bond market.