Sovereign CDS still valued despite Greek events – Fitch

The majority of European investors still believe sovereign credit default swaps represent value as a hedge, according to Fitch’s quarterly fixed income investor survey, which represents the opinions of managers of around US$7.1trn of fixed income assets.

Doubts over whether Greek CDS would trigger in a voluntary restructuring scenario appear to have devalued the instrument in the eyes of some investors though, with 28% of respondents saying they planned to reduce sovereign CDS if there was no Greek credit event. However, only 10% indicated the reduction would be significant, while 4% said they intended to increase their use of sovereign CDS.

“More than two-thirds of investors said they plan to continue using sovereign CDS for hedging and investment purposes at current levels,” said Monica Insoll, managing director in Fitch’s Credit Market Research group. “This is despite the fact that in ISDA’s opinion, voluntary exchanges of Greek debt are unlikely to trigger payments under existing CDS contracts.”

The value of sovereign CDS has come into question over the past year as authorities signalled their intent to avoid a CDS trigger when restructuring Greek debt. This led some investors to shed their sovereign CDS positions, which many hedge funds had already discarded due to the separate furore over so-called “naked” CDS, which European politicians plan to prohibit.

Dealers have since come out in defence of the product, claiming it still represents value as a mark to market hedge even if it is possible to restructure debt without CDS triggering. Any decision on the Greek CDS trigger will not be made until Greek debt is restructured – the latest plan is set to be released imminently – at which point the International Swaps and Derivatives Association EMEA Credit Determinations Committee will vote on it.

Greek net notional outstanding has gradually tracked down from US$6.3bn at the beginning of 2011 to US$3.2bn currently. Risk positions in sovereigns with tighter CDS have remained robust, though: net notional referencing Italy is currently US$22bn compared with US$26bn a year before.

“Although liquidity in Greece CDS has long since dried up with the market pricing the six-month contract of Greece at over 20,000bp, implying an imminent default, today’s survey results point to the continued use of sovereign CDS by investors more generally. This is reflected in CDS liquidity trends too, where developed market sovereigns are currently at their most liquid level since Fitch Solutions began tracking liquidity in March 2009,” said Thomas Aubrey, managing director of Fitch Solutions.