Tags: Sovereign | Bond | Risk | Default

Sovereign Bond Risk Rises After Greek Default Swaps Triggered

Monday, 12 March 2012 07:51 AM

The cost of insuring against default on European sovereign bonds rose to the highest in eight weeks after the declaration of a credit event triggering $3.2 billion of Greek debt protection contracts.

The Markit iTraxx SovX Western Europe Index of credit- default swaps on 15 governments rose four basis points to 355 at 11 a.m. in London, the highest since Jan. 18. An increase signals deterioration in perceptions of credit quality.

Investors are betting against Europe’s other troubled economies after the International Swaps & Derivatives Association’s ruling bolstered confidence in the market for hedging sovereign bond holdings. ISDA’s determinations committee meets again today to prepare for an auction to settle Greek swaps.

“From the point of view of CDS as a product, it’s definitely a relief,” said Teo Lasarte, a credit strategist at Bank of America Merrill Lynch in London. “The focus is now shifting to recovery.”

The viability of default swaps as a hedge for about $257 billion of government debt was questioned after the effective subordination of private investors to the European Central Bank failed to trigger a credit event. Greece’s use of collective action clauses to force losses on bondholders who didn’t volunteer to participate in its debt restructuring caused the event, ISDA’s determinations committee ruled.

Boxes Ticked

“Hopefully people will see that the DC will trigger a credit event when it can tick all the boxes,” said David Geen, ISDA’s general counsel in London. “Hopefully that will give people confidence the product works.”

Traders are holding an auction, which will set a recovery value on the underlying bonds, on March 19 to “maximize” the number of securities that can be used to set payout amounts, ISDA said in a March 9 statement. Greece extended its exchange offer to holders of non-Greek law bonds to March 23.

“It was always likely that CDS would trigger,” said Elisabeth Afseth, a strategist at Investec Bank Plc in London. “Confirmation may be giving bit of confidence that CDS is still useful as a hedge, and you could see the reason someone might want to protect the likes of Portugal on the back of that.”

The cost of insuring corporate and financial debt was little changed today, according to BNP Paribas SA. Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings climbed 0.5 basis points to 582.5. The Markit iTraxx Europe Index of 125 companies with investment- grade ratings rose 0.5 basis points to 133.5 basis points.

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers rose one basis point to 213 and the subordinated index climbed two to 357.

“The market is taking it in stride,” said Harpreet Parhar, a strategist at Credit Agricole SA in London. “The sovereign crisis isn’t over.”

A basis point on a credit-default swap protecting 10 million euros ($13.1 million) of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

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Monday, 12 March 2012 07:51 AM
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