UPDATE JANUARY 16, 2012:
The possibility of retrospectively applying Collective Action Clauses (CACs) to existing Greek debt has been discussed of late. Would the inclusion or activation of a CAC trigger a Credit Event?
...Generally, however, the inclusion of a CAC would not, in and of itself, be expected to trigger a Credit Event.
...could trigger if the other requirements of the Restructuring Credit Event were met (for example decline in creditworthiness), as its effect would be to bind all holders of the relevant debt.
JULY 8:
What triggers CDS?
...
A CDS is triggered when a Credit Event occurs. There are three Credit Events that are typically used for Western European Sovereigns (including Greece), they are:
Failure to Pay;
Repudiation/Moratorium and
Restructuring.
We will focus on Restructuring for these purposes.
The Restructuring Credit Event is triggered if one of a defined list of events occurs, with respect to a debt obligation such as a bond or a loan, as a result of a decline in creditworthiness or financial condition of the reference entity. The listed events are: reduction in the rate of interest or amount of principal payable (which would include a “haircut”); deferral of payment of interest or principal (which would include an extension of maturity of an outstanding obligation); subordination of the obligation; and change in the currency of payment to a currency that is not legal tender in a G7 country or a AAA-rated OECD country. The decline in creditworthiness or financial condition requirement is intended to filter out restructurings that occur as a result of improved financial condition.
Does it matter whether the event is “voluntary” or “mandatory”?
The CDS Definitions do not refer to a distinction between voluntary and mandatory events, though it does come up indirectly. An important element of the definition of Restructuring is that the event has to occur in a form that binds all holders of the "restructured" debt. Thus, for example, if bonds contain a Collective Action Clause (CAC) with a 75% threshold for making a change to bond terms, then if 75% or more of the holders vote in favour, that change is binding on all the holders, even those that voted against. That is, the change does not have to be agreed upon by all the holders to trigger a Credit Event, just the relevant majority of them. In that sense, the change is “mandatory” for those who voted against it. We understand that Greece’s domestic law debt, which accounts for over 90% of all of its outstanding debt, does not contain CAC clauses.
Would a debt exchange trigger a Credit Event?
A voluntary debt exchange typically would not trigger a Credit Event. A restructuring credit event requires an amendment of terms of outstanding bonds or loans, whereas an exchange means the original bonds are redeemed and replaced with new bonds on the new terms. Economically they may be the same but legally they are different, which could have very different consequences for CDS.
If Greece’s debt were restructured in a way that did not trigger a Credit Event, would this call into question the utility of CDS as a hedging tool?
No. It has always been understood that the Restructuring definition cannot catch all possible events. Restructuring was, in fact, dropped as a Credit Event for North American investment grade names because it was felt to be unnecessary. It was, however, maintained in Europe because European companies tend to restructure their debt where North American companies would reorganise under Chapter 11 (which would trigger the Bankruptcy Credit Event). If a creditor is hedging using CDS, and declines to participate in a voluntary restructuring, then the creditor would still hold its original debt claim and its CDS hedge, which would continue to protect against future non-payment or a mandatory restructuring for the remaining term of the CDS.
According to the Depository Trust & Clearing Corporation’s CDS data warehouse, the total net exposure of market participants who have sold CDS credit protection on Greek sovereign debt is approximately $3.7bn as of 10-21- 2011.
Regulators have access to additional data, including individual firm CDS exposures.
http://www2.isda.org/attachment/Mzg4NA==/GreekSovQandAUpdate2012-01-16_FINAL.pdf
The possibility of retrospectively applying Collective Action Clauses (CACs) to existing Greek debt has been discussed of late. Would the inclusion or activation of a CAC trigger a Credit Event?
...Generally, however, the inclusion of a CAC would not, in and of itself, be expected to trigger a Credit Event.
...could trigger if the other requirements of the Restructuring Credit Event were met (for example decline in creditworthiness), as its effect would be to bind all holders of the relevant debt.
JULY 8:
What triggers CDS?
...
A CDS is triggered when a Credit Event occurs. There are three Credit Events that are typically used for Western European Sovereigns (including Greece), they are:
Failure to Pay;
Repudiation/Moratorium and
Restructuring.
We will focus on Restructuring for these purposes.
The Restructuring Credit Event is triggered if one of a defined list of events occurs, with respect to a debt obligation such as a bond or a loan, as a result of a decline in creditworthiness or financial condition of the reference entity. The listed events are: reduction in the rate of interest or amount of principal payable (which would include a “haircut”); deferral of payment of interest or principal (which would include an extension of maturity of an outstanding obligation); subordination of the obligation; and change in the currency of payment to a currency that is not legal tender in a G7 country or a AAA-rated OECD country. The decline in creditworthiness or financial condition requirement is intended to filter out restructurings that occur as a result of improved financial condition.
Does it matter whether the event is “voluntary” or “mandatory”?
The CDS Definitions do not refer to a distinction between voluntary and mandatory events, though it does come up indirectly. An important element of the definition of Restructuring is that the event has to occur in a form that binds all holders of the "restructured" debt. Thus, for example, if bonds contain a Collective Action Clause (CAC) with a 75% threshold for making a change to bond terms, then if 75% or more of the holders vote in favour, that change is binding on all the holders, even those that voted against. That is, the change does not have to be agreed upon by all the holders to trigger a Credit Event, just the relevant majority of them. In that sense, the change is “mandatory” for those who voted against it. We understand that Greece’s domestic law debt, which accounts for over 90% of all of its outstanding debt, does not contain CAC clauses.
Would a debt exchange trigger a Credit Event?
A voluntary debt exchange typically would not trigger a Credit Event. A restructuring credit event requires an amendment of terms of outstanding bonds or loans, whereas an exchange means the original bonds are redeemed and replaced with new bonds on the new terms. Economically they may be the same but legally they are different, which could have very different consequences for CDS.
If Greece’s debt were restructured in a way that did not trigger a Credit Event, would this call into question the utility of CDS as a hedging tool?
No. It has always been understood that the Restructuring definition cannot catch all possible events. Restructuring was, in fact, dropped as a Credit Event for North American investment grade names because it was felt to be unnecessary. It was, however, maintained in Europe because European companies tend to restructure their debt where North American companies would reorganise under Chapter 11 (which would trigger the Bankruptcy Credit Event). If a creditor is hedging using CDS, and declines to participate in a voluntary restructuring, then the creditor would still hold its original debt claim and its CDS hedge, which would continue to protect against future non-payment or a mandatory restructuring for the remaining term of the CDS.
According to the Depository Trust & Clearing Corporation’s CDS data warehouse, the total net exposure of market participants who have sold CDS credit protection on Greek sovereign debt is approximately $3.7bn as of 10-21- 2011.
Regulators have access to additional data, including individual firm CDS exposures.
http://www2.isda.org/attachment/Mzg4NA==/GreekSovQandAUpdate2012-01-16_FINAL.pdf
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