As European bank deleveraging continues, Middle East tensions rise, and oil prices (Brent and Crude alike) oscillate from headline to headline, we thought it intriguing that the entities with net notional outstandings in CDS markets at or near their largest in history are China (and Chinese banks), LatAm Oil companies, Abu Dhabi, and Israel. Quite a crop of potential risk bombs that at least credit traders appear to demand protection on more than others.
As we wait for more IIF announcements about the Greek Private Sector Involvement (PSI), Greek CDS remains bid above 60 points up front. For a contract that is about to be "worthless", this seems to have a lot of value. Why would Greek CDS still be so well bid? Whether it is stubbornness, stupidity, or more simply a reality check on the IIF's negotiating power (just how many bonds do they speak for?) and the future unsustainability of Greek debt anyway, it seems that an impressive immediate exchange of all Greek debt with at least a 50% notional reduction, 30 year maturity, and low coupon is pretty well priced in (away from actual Greek bonds that is). Anything less is likely to disappoint the market as the realization that nothing is fixed sinks in, and that this may not even take near term "hard default" off the table (this PSI is a default no matter how it is spun even if it isn't a Credit Event).
What would a Collective Action clause achieve? Let’s say they institute a 75% agreement clause, so that if at least 75% of the holders of anyindividual bond issue, agree to the terms, then all bondholders are forced to accept the new terms. Will adding a Collective Action Clause make investors agree to the changes? I don’t see why that would happen. If you didn’t agree to the plan being proposed by Greece now, why would you agree to the plan if all they have done is institute a Collective Action Clause. You wouldn’t, so you would still have the same group of holdouts. What happens if a bond doesn’t get 75% agreement? Then those that agree get the new bonds, and those that don’t agree keep the old bonds. Same as now. But if it is the same as now, why bother? Maybe they need to make it 50% agreement? Or 10%? In any case, there may be individual bonds that don’t meet the Collective Action threshold. For those bonds, it is exactly the same as it is now – except that the government changed the rules retroactively and jammed it down your throats (but more on that later). What happens if 80% of the holders of a particular bond agree? Then all bondholders are subject to the agreement. Well, guess what, that is a Credit Event!
The last two weeks have been full of headlines regarding the volatility and decompression of sovereign spreads around the world. What has been more intriguing to us than day-after-day of discussing Greek 2Y yields or French 5Y CDS has been the relative increases in net notional credit protection outstanding on Germany. The German credit worthiness and sovereignty stands at the heart of any solution to the crises in the Euro-zone and it appears market participants are increasingly pricing in that risk transfer. This is exactly the same transmission we saw in the US when the Fed/TSY announced day-after-day of acronym-laden support mechanisms and shouldered more and more of the private balance sheet risk. This week, both Brazil and Germany overtook Spain in terms of net notional CDS outstanding.
While the CDS market for various insolvent European names whose credit default swaps are trading 10 or more points upfront has become more or less nothing but noise, and the only true way to hedge risk exposure, courtesy of ISDA's advance warning that no matter what a CDS will never be triggered, is to sell cash bonds, the market for default risk is quite active for those names which still trade in a reasonable range: such as between 50 bps and 200 bps. And while the Bloomberg chart below demonstrates on an absolute basis the US is due for a two notch downgrade by S&P based on the recently observed spike in US default risk, it is DTCC data that is more troubling. As most revel in the latest nonsensical Group of 6 plan, the bond vigilantes are already quietly setting the trap.