As uncertainty remains over whether a voluntary restructuring of Greek debt will be pushed through, market participants looking to shield themselves from a default have been forced to re-position their short-dated credit default swap protection.
The market has focused on the €14.5bn Greek government bond that matures on March 20, which observers believe to be too big a redemption for Greece to service without either receiving another loan or haircutting its debt. JP Morgan fixed income analysts handicapped the probability of a disorderly default on March 20 at 25% in a report today.
Some investors had previously identified this as a tipping point and consequently bought CDS referencing the March bond. However, investors had not realised that the bond’s seven-day grace period could effectively render their protection worthless.
In other words, protection pay-outs would not be triggered on the March 20 CDS if Greece failed to pay the bond, as the CDS contract would have expired before the end of the bond’s grace period. As a result, protection buyers have been dumping their March protection and buying longer-dated protection to ensure they would benefit from a failure to pay credit event on the March bond.
The head of European credit trading at a European bank estimated seeing volumes of €50-100m so far this year rolling out of the March contract.
“We have had a lot of questions around the Greece March contract, and the answer is if there is a failure to pay on the bond, the March CDS will not trigger because of the grace period. We’ve seen clients selling out of the March contract and buying the June contract instead,” said the head of European credit trading at a European bank.
The March contract was trading at around 40 points upfront in late January, compared to the June contract at around 45 points upfront. Gavan Nolan, director in credit research at Markit, said there was no real market in one-month Greek CDS being quoted currently, although the three-month contract is currently around 55 points upfront.
A head of credit trading at another major house said he had also seen the roll from March into June, but believed the majority of that activity took place in late November.
There has been much speculation over whether Greek CDS would trigger as authorities have looked to restructure Greek debt voluntarily. Most market participants believe it will now trigger if the current restructuring plan is approved and collective action clauses are exercised to haircut the outstanding debt.
This has not stopped some CDS users from exiting their positions altogether, though. “We’re taken off all our Greek CDS,” one hedge fund manager told IFR last week.