A few interesting stories popped up on Dow Jones Newswire today, again bringing up some questions regarding the credit triggers for the CDS (Credit Default Swap) market. A snippet of the story is quoted (highlighted by myself):
Standard & Poor's Friday said in a report that for issuers rated at Greece's level, single-B, a "voluntary" debt exchange would likely be default if creditors received securities with terms less favorable than are available in the secondary market. With 10-year Greek debt yielding 15% in the secondary market and two-year debt yielding over 20%, that is almost certain to be the case under the exchange process planned by euro-zone governments.
At the same time EU politicians are stating that
* DJ Deal Will Avoid Greek Credit Event But Not Necessarily Ratings Downgrade – Officials
Or looking more closely at the article:
“The ECB has opposed more coercive measures aimed at getting Greece's private-creditors to continue providing financing for the country starting in 2012. But the debt-exchange process envisioned by the governments won't rewrite existing bond contracts or trigger a credit event, the officials said, partly easing the ECB's concerns that private-creditors would be forced to contribute financing.”
CDSes are normally written under the ISDA Master Agreement (International Swaps and Derivatives Association) , in which a credit event follows in the situations
- reference entity bankruptcy
- failure to pay,
- obligation acceleration,
- repudiation (When one party refuses to honor its terms in a loan contract. )
If we make a note of the S&P statement, voluntary is enclosed in quotes. I suspect this is based on the amount of incentives involved for the current bondholders to participate on a “voluntary” basis. One example of such an incentive would be
The governments are also looking to the European Central Bank to encourage the exchange offer by accepting the new Greek bonds as collateral for lending while refusing to accept the old ones, the officials said.
The argument would then be, if enough (too many) incentives are given to participate on a voluntary basis, it would be a de-facto obligation acceleration and as such constitute a credit event.
Now that prompts the following question from my side. If something would qualify as a credit event for a B rated issuer (and keep in mind the debt has already been down-notched substantially), but could be avoided if the rating agencies further downgrade the rating on a post-hoc basis, as can be inferred from the politicians suggestion. Are they really making a mockery of the CDS market? If this is the situation a credit event would “never” be a reality for sovereign bonds.
Can we really have a situation where that would not happen if the rating agencies would further downgrade the issuer after the fact?