Sunday, May 1, 2011

What are CDS really worth?

International Financing Review
April 30, 2011

It's a question that politicians have frequently asked over the past couple of years when lambasting the credit default swap market. Now, as rumours abound that Greece will look to avoid triggering CDS when restructuring its debt, even some of the instrument’s most fervent supporters are questioning its value.

Senior derivatives users, including a member of the board at the International Swaps and Derivatives Association, have warned that the intrinsic value of credit default swaps could be severely compromised if Greece restructured its debt without triggering a credit event.

As a consensus has grown among market participants that authorities will look to avoid triggering CDS when restructuring Greek bonds, market participants have been scrambling to understand the potential ramifications of such a development, with many fearing the worst.

“If there is a restructuring that doesn’t trigger CDS, that calls into question the value of the instrument,” said the ISDA board member. “If you buy CDS and it doesn’t economically protect you as expected, you will question the usefulness of that tool as a risk mitigant, and you’ll be unlikely to ever buy protection again.”

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