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Guest Post: Credit Events And The Lire

Tyler Durden's picture


From Peter Tchir of TF Market Advisors

Credit Events And The Lire

We seem to be finally getting to a point where we may get a real Credit Event for CDS contracts with Greece.  Over the past few months, we have learned that any “Restructuring” is voluntary no matter how much it is coerced from the participants.  Now that Greece looks likely to trigger a Credit Event with a good old fashioned Failure to Pay, we are seeing CDS well bid across the board on sovereign debt.

I would avoid buying protection on Italy.  I don’t think Italy will do well, but I believe that they are most likely to take actions that makes their CDS useless.  I have included (without permission, the Restructuring Definition from the 2003 ISDA Credit Derivatives Definitions).  The scenario that I could see playing out, is that Italy could officially adopt the Lire as legal tender.  If they paid all their interest and principal back in Lire it would not be a Credit Event.  A few other countries could use this loophole, but I see Italy as being the most likely, and the one that would have the most pain for the CDS market.

For a Restructuring to Credit Event it has to meet some conditions.  We have already been made to understand that anything that is “voluntary” is not a Credit Event.  So if investors agreed to be paid back in another currency, it wouldn’t be a Credit Event in any case.  But let’s just assume that with the bigger countries, some investors will resist any “voluntary” program.  Then for a Restructuring Credit Event to occur, either the interest rate has to be lowered, some debt has to be forgiven, the maturity of the debt has to be extended, or the debt has to be changed to something other than a Permitted Currency.

It is the Permitted Currency clause that would allow a country like Italy to keep all the terms of bonds the same, but pay back in Lire, and not trigger a CDS Credit Event.  Permitted Currency includes the legal tender of any G-7 country.  Germany and France could also play this game, but they have spent so much time defending the Euro they seem the least likely to do it.  Italy on the other hand would welcome a weak lire.  They could stop worrying about austerity and focus on getting a Ferrari in every garage in the Hamptons.  Seriously, the Italian economy could perform extremely well if they revert back to making Lire legal tender (note, it does not say it has to be the only legal tender of a country, just that it has to be legal tender, so Italy could continue to use Euro while it re-introduces the Lire). 

The pain on being short Italian CDS on a trade like this could be immense.  CDS is currently trading at 500 bps.  It could tighten 100’s of bps since Italy would now be able to print their way out of the problem.  Even worse, the CDS is denominated in $’s.  If the $ strengthens on the back of Italy leaving the Euro (a likely short term reaction), then the losses are amplified. 

The basis trade could be particularly painful.  Italian bonds would be more likely to get paid off, but the first reaction is likely for bonds to trade down.  It is unrealistic to expect Lire denominated bonds to have the same coupon as bonds denominated in Euro’s.  The bonds would drop in price and the CDS would tighten.  Massive pain for basis traders.

Of all the countries, it seems safer to secure a borrow on Italian bonds and short them, rather than buying CDS.  The scenario described may be unlikely, but I think there is a real chance, and given the size of the Italian bond market, it is well worth the effort to focus on getting a good short on the bonds rather than trading it via CDS.

Section 4.7. Restructuring.

(a) "Restructuring" means that, with respect to one or more Obligations and in relation to an
aggregate amount of not less than the Default Requirement, any one or more of the following events
occurs in a form that binds all holders of such Obligation, is agreed between the Reference Entity or a
Governmental Authority and a sufficient number of holders of such Obligation to bind all holders of the
Obligation or is announced (or otherwise decreed) by a Reference Entity or a Governmental Authority in
a form that binds all holders of such Obligation, and such event is not expressly provided for under the
terms of such Obligation in effect as of the later of (i) the Credit Event Backstop Date and (ii) the date as
of which such Obligation is issued or incurred:

(i) a reduction in the rate or amount of interest payable or the amount of scheduled
interest accruals;

(ii) a reduction in the amount of principal or premium payable at maturity or at
scheduled redemption dates;

(iii) a postponement or other deferral of a date or dates for either (A) the payment or
accrual of interest or (B) the payment of principal or premium;

(iv) a change in the ranking in priority of payment of any Obligation, causing the
Subordination of such Obligation to any other Obligation; or

 (v) any change in the currency or composition of any payment of interest or principal
to any currency which is not a Permitted Currency.

(A) "Permitted Currency" means (1) the legal tender of any Group of 7
country (or any country that becomes a member of the Group of 7 if such Group of 7
expands its membership) or (2) the legal tender of any country which, as of the date of
such change, is a member of the Organization for Economic Cooperation and
Development and has a local currency long-term debt rating of either AAA or higher
assigned to it by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. or
any successor to the rating business thereof, Aaa or higher assigned to it by Moody’s
Investors Service, Inc. or any successor to the rating business thereof or AAA or higher
assigned to it by Fitch Ratings or any successor to the rating business thereof.

(b) Notwithstanding the provisions of Section 4.7(a), none of the following shall constitute a

(i) the payment in euros of interest or principal in relation to an Obligation
denominated in a currency of a Member State of the European Union that adopts or has adopted
the single currency in accordance with the Treaty establishing the European Community, as
amended by the Treaty on European Union;

(ii) the occurrence of, agreement to or announcement of any of the events described
in Section 4.7(a)(i) to (v) due to an administrative adjustment, accounting adjustment or tax
adjustment or other technical adjustment occurring in the ordinary course of business; and

(iii) the occurrence of, agreement to or announcement of any of the events described
in Section 4.7(a)(i) to (v) in circumstances where such event does not directly or indirectly result
from a deterioration in the creditworthiness or financial condition of the Reference Entity.

(c) For purposes of Sections 4.7(a), 4.7(b) and 4.9, the term Obligation shall be deemed to
include Underlying Obligations for which the Reference Entity is acting as provider of a Qualifying
Affiliate Guarantee or, if All Guarantees is specified as applicable in the related Confirmation, as provider
of any Qualifying Guarantee. In the case of a Qualifying Guarantee and an Underlying Obligation,
references to the Reference Entity in Section 4.7(a) shall be deemed to refer to the Underlying Obligor
and the reference to the Reference Entity in Section 4.7(b) shall continue to refer to the Reference Entity.


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Mon, 09/12/2011 - 10:36 | 1659486 Everybodys All ...
Everybodys All American's picture

Seriously how is that not a credit event? Why doesn't Greece use this same clause?

Mon, 09/12/2011 - 10:37 | 1659499 oogs66
oogs66's picture

because the lawyers always win...regulators should have had this on exchanges long ago

Mon, 09/12/2011 - 10:48 | 1659537 X.inf.capt
X.inf.capt's picture

amen, brother

Mon, 09/12/2011 - 10:48 | 1659535 skistroni
skistroni's picture

According to the ISDA paper, we could offer our local currency if our country was rated AAA by Moody's or Fitch or S&P.

Tough luck.

We'll do it anyway. Coming soon in a weekend near you. 

Mon, 09/12/2011 - 10:52 | 1659550 citta vritti
citta vritti's picture

Greece not G-7 (according to Wikipedia = Canada, France, Germany, Italy, Japan, U.K., U.S.) 

Mon, 09/12/2011 - 10:35 | 1659488 Mike2756
Mike2756's picture

Can the u.s. annex mexico and use pesos to pay off the debt?

Mon, 09/12/2011 - 10:53 | 1659555 Cthonic
Cthonic's picture

Mexicans can't even pay off their own debt with pesos; much of it is denominated in yen and euros.

Mon, 09/12/2011 - 10:36 | 1659495 HROLLER
HROLLER's picture
CIA Whistle Blower Susan Lindauer‏

Please watch minute 7 and on.....

Mon, 09/12/2011 - 14:05 | 1660258 Pegasus Muse
Pegasus Muse's picture

You need to watch it.  You need to send it to your friends and family.  The corruption and evil runs so deep people .... so deep ....

Mon, 09/12/2011 - 10:37 | 1659500 Mitzibitzi
Mitzibitzi's picture

Also, isn't that kinda, sorta.... well, exactly like the 'competing local currencies' thing that we're told is absolutely not allowed in any way, shape or form?

Mon, 09/12/2011 - 10:38 | 1659505 IBelieveInMagic
IBelieveInMagic's picture

Educative post -- good to know the loopholes thru which this problem will be punted!

Mon, 09/12/2011 - 10:39 | 1659507 Irish66
Irish66's picture

Looks like GS has got some news coming

Mon, 09/12/2011 - 10:39 | 1659510 LawsofPhysics
LawsofPhysics's picture

When bogus paper is the problem, there is no paper solution.

Mon, 09/12/2011 - 10:41 | 1659516 Derpin USA
Derpin USA's picture

Peter's a great analyst, but he seems to be committed to rearranging the deck chairs. I guess as long as the band is playing, right?

Mon, 09/12/2011 - 10:42 | 1659518 RobotTrader
RobotTrader's picture

Some kind of scheme or scam will be concocted, no doubt to rescue Europe.

Some program nobody here has thought of yet.

Mon, 09/12/2011 - 11:01 | 1659590 tocointhephrase
tocointhephrase's picture

We have a spillage on isle 17. Robo to isle 17, Robo to isle 17.

Mon, 09/12/2011 - 11:03 | 1659608 tocointhephrase
tocointhephrase's picture

did you sign in twice or sommit?

Mon, 09/12/2011 - 10:52 | 1659551 snowball777
snowball777's picture

No, Peter, Italy is not England. Logic FAIL.

Mon, 09/12/2011 - 10:55 | 1659564 Gandalf6900
Gandalf6900's picture

I still have some Lira, it looks much more real than the Euro monopoly money

Mon, 09/12/2011 - 10:58 | 1659573 milanitaly
milanitaly's picture

We will have Dracma soon, and will be srtonger than the German-Franch Euro.

Mon, 09/12/2011 - 11:07 | 1659628 Bam_Man
Bam_Man's picture

I am looking forward to the Italian re-introduction of the Lire.

It will make my favorite Brunello, Barolo and Chianti Classico more affordable!

Mon, 09/12/2011 - 10:59 | 1659580 TJ00
TJ00's picture

As I recall from the deliberations of the Maastricht Treaty originally the wording for the Euro was for a "common currency" which would have allowed the Euro along side national currencies, this was changed to "single currency" so the Euro is the only legal tender in those countries within the Euro zone so it is not legally possible to reintroduce the Lire without leaving the Euro and it is not possible to leave the Euro without leaving the EU, so the idea put forward in the article is totally false.

Mon, 09/12/2011 - 11:02 | 1659599 tocointhephrase
tocointhephrase's picture

It so fucked even a whore would need to do some over time and then some!

Mon, 09/12/2011 - 11:05 | 1659619 Bam_Man
Bam_Man's picture

At this point, it is best to stay away from "paper" assets altogether.

The level of fraud and deception will reach mind-boggling levels to keep insolvency and default hidden from view.

Mon, 09/12/2011 - 11:10 | 1659652 spanish inquisition
spanish inquisition's picture

Could this be the return of reasonably priced Italian shoes?

Mon, 09/12/2011 - 11:18 | 1659689 paulie
paulie's picture

Yeah it could.

We will be exporting (again, finally) and you people will enjoy the fine Italian craftmanship at reasonable prices.

Plus you might consider buying a house in Tuscany or Sicily or Sardinia. And maybe a cheap Alfa. The Giuliettas are nice particularly if they cost half what you pay for a golf.

Like in good old 80s.



Mon, 09/12/2011 - 11:16 | 1659681 korthaj
korthaj's picture

Banking here in europe is starting to show signs of problems, "We currently have technical problems which means we can not set prices for our products. We will be back as soon as we can!", translated from swedish

The broker insists its not liquidity problems just technical problems.


Mon, 09/12/2011 - 11:20 | 1659701 wombats
wombats's picture

If Italy (and Greece) exited the Euro via this mechanism then obviously their new Lira and Drachmas would be nearly worthless, but what about the Euro?  Wouldn't the Euro gain in value (relative to the dollar) by getting rid of Italy and Greece?

Mon, 09/12/2011 - 11:20 | 1659706 paulie
paulie's picture

CDS should be declared illegale altogether.

They are the cause of the current crisis and they are only a means of getting around the Basel 2 agreements.



Mon, 09/12/2011 - 11:40 | 1659801 Gordon Freeman
Gordon Freeman's picture

We are so far through the looking glass, at this point, that all of this is just the purest conjecture.

Mon, 09/12/2011 - 11:52 | 1659852 bogey4
bogey4's picture

lira - singular

lire - plural

Mon, 09/12/2011 - 12:39 | 1659988 Negro Primero
Negro Primero's picture problema:

"Italy claims Germany must pay compensation to victims of Nazi war crimes, but Germany refuses." ....and Greece too: "Also arguing against Germany is Greece, representing relatives of the victims of a 1944 German massacre at Distomo, in Greece.",,15380969,00.html

Tue, 09/13/2011 - 21:59 | 1665980 moxia19
moxia19's picture

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