Analysts have been buzzing lately over whether or not a Greek debt restructuring would characterise a credit event and ultimately trigger credit default swap (CDS) contracts. EU leaders have pushed the idea of a voluntary default that would not trigger the CDS. Most financial analysts have been pretty set against this, arguing that a high-handed move by EU leaders would destroy the massive industry of CDS—one of the only direct ways to hedge against a sovereign or corporate default.
So why are EU leaders doing this? Krishna Memani, Portfolio Manager and Director of Fixed Income at OppenheimerFunds, actually believes that avoiding a credit event is a reasonable and completely practical move.
He gives two reasons for that:
- The European banking sector, which probably has a bigger position on the wrong end of the CDS trade than it would like to let on, would not go under. Investors already expect CDS not to trigger and they’ve made investment decisions accordingly.
- Lack of a Greek credit event would eradicate the only true vehicle for speculating against sovereign debt.
We sat down with him at today’s Bloomberg Link conference to find out more:
Obviously everyone’s concerned about the uncertainty a credit event would cause. But wouldn’t the failure of the CDS market in general have a greater impact?
The impact on the sovereign CDS market would be bad, but the likelihood of the impact on the corporate CDS sector being that catastrophic is likely an exaggeration. We have gone through lots of credit events and you can shake the credit event in the corporate credit sector and there the payouts in Lehman’s case have been honored—the whole process 1-2-3.
I think what would happen is that the CDS market would get back to what it was supposed to be, which was a way for market participants to hedge their corporate credit risks while they proliferated into hedging also into other sectors…
So credit default swaps shouldn’t be able to hedge against sovereigns in general?
Well, take it to a higher level. If you buy U.S. credit default protection, you’re counting on somebody to pay you. And who do you think would be around in that situation to begin with? A lot of it is really capital management driven than it is real protection.
So I think that a potential Greek default and non-triggering will basically wake people up. I think for the most part people have recognised and are kind of paring their positions down. if they can’t pare their positions down then they want to win the lottery ticket.
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