ISDA says the voluntary private sector involvement (PSI) in the new Greek rescue package is unlikely to trigger a CDS credit event, based upon plans it saw for the scheme some weeks ago. If ISDA sticks to that approach, then there's a pretty fundamental question to be asked: what is the point of buying European sovereign CDS?
The European leaders have said that PSI will apply for this Greek package and this Greek package only. Realists will beg to differ. The private sector is involved because politicians have nowhere else to turn now that taxpayers no longer want to keep writing cheques for the Greeks. Involving bondholders was the only option.
And if taxpayers will no longer sanction writing cheques to the Greeks, then you can bet your bottom euro they are not about to shell out for the Irish or the Portuguese, let alone the Italians and the Spanish.
Of course, those same politicians also tell us that it will not come to that with the other four peripheral countries. Greece is special.
Many bondholders disagree — and they are the ones who have been proved correct so far. It would not be a wild leap of the imagination to think that a similar PSI scheme to that used in Greece would be deployed if one or more of Portugal, Ireland, Spain or Italy did need assistance to avoid going down in a ball of flames.
Keeping the restructuring voluntary means the banks that have written all those CDS contracts will only take losses on their bond holdings — rather than having to pay out on CDS contracts too. In the case of CDS on Greece, there is $78.4bn equivalent of gross outstanding CDS notional, which nets off to only $4.6bn worth of contracts with an economic interest, according to DTCC.
But this bail-out was never about Greece alone. And the numbers get much bigger once the other peripheral countries are involved. Ireland’s net figure is $4.2bn, Portugal’s is $6bn. Spain’s is almost double those two combined, at $18.6bn. Italy’s is $23.6bn.
That is an awful lot of insurance. But if it can be conveniently ignored by voluntary debt restructuring schemes, what does it mean? There is no doubt that bondholders will be materially worse off after the Greek process, and yet they will not recoup any benefit from their insurance.
A disorderly default would, you'd think, be enough even for ISDA to declare a credit event — although you would have to question how many banks that have sold protection would be able to pay up in that situation. Either way, CDS is looking a whole lot less like a hedge and a whole lot more like a waste of money.