WSJ: Don΄t write off Greece΄s CDS yet

The devil is in the detail when it comes to defaults. Standard & Poor΄s has declared Greece to be in a state of "selective default," but the 10 banks and five investors on the International Swaps and Derivatives Associations΄ Determinations Committee unanimously agreed Thursday that credit-default swaps on Greece΄s debt hadn΄t been triggered. That wasn΄t a surprise. But unless there is an extraordinarily high voluntary takeup of Greece΄s bond swap offer, the process will almost certainly end up triggering CDS in the next two weeks or so, according to Wall Street Journal.

The committee was asked to judge two questions: whether a restructuring credit event had taken place, and whether holders of Greek law bonds had been subordinated by the European Central Bank in a way that would trigger CDS. The ECB has swapped its Greek bonds for new bonds that won΄t be subject to collective-action clauses that could be used to enforce the restructuring, thus excluding it from losses.

The first question is relatively easy: While Greece has launched a process that will almost certainly end in the restructuring of its debt, that restructuring has yet to be implemented. The second question is trickier, but relies on a legal definition of subordination that looks at the contractual position of creditors after default. On the basis of CDS documentation, the insertion of collective-action clauses in some Greek bonds isn΄t a trigger event. The S&P decision makes no difference. Ratings definitions don΄t necessarily match up to CDS documentation.

Thursday΄s decision has no bearing on future rulings by the committee. If Greece activates its collective-action clauses to enforce the restructuring on all private bondholders, the committee will almost certainly face another deliberation. The ISDA already has said the use of such a clause to reduce the debt outstanding and change interest rates could trigger CDS. If they don΄t, investors really will have grounds to question the value of CDS. But there isn΄t long to wait to find out: The Greek offer runs until the evening of March 8.