Greek debt talks cast doubt over sovereign CDS

Financial Times
May 18, 2011

In one sense, Greece may be about to get its revenge on the speculators blamed by politicians for exacerbating the country’s debt crisis.

If eurozone leaders press ahead with plans to extend Greek bond maturities in a “soft” or voluntary debt restructuring, then traders in credit default swaps could be one of the main casualties.

Sovereign CDS, which insure investors against the risk of a bond default, are facing a critical moment in their short history. The first sovereign CDS trades were made about 10 years ago and the question of whether or not this insurance will pay out could soon be put to the test.

A voluntary restructuring of Greek debt, or “reprofiling”, as European Union policymakers describe it, threatens to undermine the intrinsic value of buying the derivatives because such a restructuring is unlikely to amount to a so-called “credit event”.

This means that the banks and investors who had bought CDS protection against any restructuring would receive nothing in recompense for any losses in interest due or principal invested in Greek bonds.

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