Greek CDS Not Totally Worthless Yet

Yesterday’s decision by the International Swaps & Derivatives Association (ISDA) declared that Greece had not yet caused a “credit event” equivalent to a default. Many holders of credit default swaps (CDS) on that debt probably thought it was safe to toss those swaps into the garbage.

Not so fast, there might be some value there yet. When the actual debt swap takes place next week, Greece is very likely to invoke the so-called “collective action clauses” that essentially force bondholders to take a loss on their old bonds in order to get the new bonds. The ISDA, which declined to enforce the clauses yesterday, will be forced to enforce the clauses when that exchange happens. Then the exchange becomes coercive, and — Bingo! — a credit event has occurred. Those CDS still have a pulse.

The argument for paying the CDS is that if the swaps are not payed, traders will lose all confidence in the ISDA and the swaps market in general. The argument against paying the CDS is that doing so will encourage traders to bet against the sovereign debt of the eurozone’s weaker nations.

Fortunately there are only about $3.5 billion in outstanding CDS on Greek sovereign debt according to the Depository Trust & Clearing Corp., so the damage isn’t much one way or the other. Whatever happens, there is sure to be an outbreak of wailing and gnashing of teeth from the side that loses.