Another Reason Why A Series Of European Restructurings Could Be Disastrous

With the potential for a European restructuring on default event still high, it’s important to note just how significant such an event would be in terms of the derivatives market.

Note that 8 of the top 20 CDS outstanding are on eurozone sovereigns, according to Morgan Stanley. Greece may not rank high, so whomever sold those CDS contracts may not have to pay too much out in that event, but similar events in Italy or Spain would be extremely costly for whomever sold the contracts.

Similar to how AIG was left to pay out on CDS contracts in the wake of the Lehman Brothers bankruptcy, and the collapse of the mortgage backed security market, whatever firm issued these CDS contracts will have to pay in the wake of such a default event. Whether or not there is a firm exposed to the degree of AIG in the sovereign CDS market is unknown.

And what constitutes a default event? It is a little confusing, but Morgan Stanley analysts suggest that a restructuring event could also be counted as a default, and trigger CDS. That also includes a “voluntary” restructuring, so long as it is “binding on all holders.”

Hence the current aversion to a restructuring event.

The top 20 contracts outstanding, from Morgan Stanley:


[credit provider=”Morgan Stanley”]