St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
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St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
Steering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015 2010 has been whether sovereign debt restructurings trigger credit default swaps (CDS). For the first time since A1G threatened to default on its CDS in 2008, the Greek debt crisis returned CDS to the global spotlight. The question of whether sovereign debt restructurings trigger CDS matters not on St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ly for buyers and sellers of CDS, but for financial stability more generally. While there was universal agreement that a failure to pay when due wouldSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
trigger a failure to pay credit event under CDS, whether formally ‘voluntary’ restructurings also trigger a credit restructuring event was uncertain Steering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015shifting CDS quicksand, and avoid a credit event under CDS at all costs. This desire to avoid a payout on Greek CDS was a central motivation why Eurozone policymakers opted for a ‘voluntary’ restructuring of Greek debt in July 2011? They reinforced this strategy in October 2011 by calling for a ‘vol St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015untary’ reduction of 50 percent of the net present value on privately held Greek debt.3 When Greece and the Eurozone implemented the formally voluntarSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
y Greek restructuring in February 2012, Greece proposed substantially higher losses for private sector holders than those contemplated back in the sumSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ggering CDS would open up an additional channel of contagion running from sovereign financial distress to instability in the financial sector. CDS protection sellers on Greek debt may be unable to deliver on their promises, leading to a potential chain reaction across the financial system more broad St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ly.4 The chief concern of policymakers was that a systemically important seller of CDS on Greece, such as A1G in the case of Lehmann Brothers, might fSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
ail to deliver on its CDS promises. Their risk-aversion is due to the1University Lecturer, University of Cambridge and Lauterpacht Centre for InternatSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015 Gulati. Edward Murray and Daniel Peat for discussions. All views expressed herein are my own.2Institute of International Finance, Financing Offer, 21 July 2011.3Statements of Heads of State and Government, Main Results of Euro Summit, 26 October 2011.* Greek Crisis Raises New Fears over Credit Defa St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ult Swaps, New York Times, 22 February 2012.1potentially systemic consequences of triggering CDS on Greek debt. They preferred the certainty of exposiSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
ng the holders of Greek debt to substantial losses over the uncertainty of having random institutions in the official and shadow banking sector fall pSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015y were overdone, most prominently the International Swaps and Derivatives Association (ISDA).5 The Economist called the belief that triggering Greek CDS would produce ‘Lehman-like market paralysis' erroneous. The danger of triggering sovereign CDS was a market bogeyman.6 At least in hindsight, this St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015view proved to be correct. The declaration of a credit restructuring event following the Greek restructuring in March 2012 did not cause market turmoiSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
l, because it was widely anticipated and because the net volume of CDS on Greece debt was comparatively small at around 4 billion €. However, this forSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015e Greek debt crisis first erupted.The design ultimately chosen for the Greek debt restructuring in February/March 2012 was a belated recognition that no sustainable restructuring solution existed for Greece that avoided triggering CDS. Under the parameters established by the Troika, Greece needed lo St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015o much debt relief from the private sector for a restructuring to be feasible without important elements of coercion. Eurozone policymakers realized tSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
hat the price to pay for insisting on a CDS-immune restructuring would have been too high in terms of free-riding by creditors and Greek debt sustainaSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015 end anticipated that the use of retroactive collective action clauses (CACs) would trigger CDS.With the benefit of the experience on the Greek restructuring February.'March 2012, this article assesses how likely five types of restructuring, ranging from a simple bond exchange over the use of CACs t St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015o exit consent are to trigger CDS. The paper is structured into five parts. Part I outlines techniques for restructuring sovereign debt; Part II descrSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
ibes how CDS work and the challenges they raise in debt restructurings. Part III examines the most important credit event in5ISDA is a market associatSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015t* in the case of the proposed Greek restructuring was ^misguided*, When it Comes to Sovereign CDS, Collateral Is King, November 29, 2011, available at isda.derivativiews.org;6Eurozone: call banks bluff over CDS, Financial Times Editorial, 26 October 2011.2the context of sovereign debt restructuring St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015s, the restructuring credit event. Part IV analyses whether five different types of sovereign debt restructurings techniques trigger CDS. Finally, ParSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
t V examines the central role of ISDA determinations committees.I. Sovereign debt restructuring techniquesTo achieve success in a restructuring, debtoSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ce to its inability to pay, a government hint that absent a 'voluntary' restructuring resulting in an overall net present value reduction of its outstanding indebtedness, it would in due course be forced to suspend payment - an outcome that would be considerably worse in terms of payoffs for credito St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015rs as a group. It may also entice creditors into a restructuring by committing only to pay the restructured debt, intimating that non-participating crSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
editors will suffer a default. The mere threat can be highly effective in encouraging participation, and may be just enough to achieve a voluntary resSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015 exchange. The country sent its creditors the unambiguous message that the exchange offer was indeed final, and would not be improved upon. First, it used a most favoured creditor clause. Second, the Argentinean Congress barred the government from granting better treatment to nonparticipating credit St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ors in the future (the so-called lock-out law)’ - a prohibition on more favourable treatment of creditors that chose to remain outside the restructuriSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
ng. In 2010, Argentina carried out a second restructuring, in an attempt to mop up a large part of the remaining holdout creditors, on very similar teSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015e insertion and later invocation of collective action clauses into debt instruments issued by Greek law. The Greek and other Eurozone governments, as well as the European Central Bank, leaned on private lenders to tender in the exchange. In return for giving up their existing instalments, holder of St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015Greek debt were offered a package of new bonds issued by Greece (31.5 € for every 100 €), bonds by the European Financial Stability Facility (15 for eSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
ver}-100 €) and GDP-linked securities. *Ley 26.017 (Argentina).3•Voluntary' in the context of sovereign debt restructurings is somewhat of an oxymoronSteering sovereign debt restructurings through the CDS quicksandMichael Waibel1 2A central policy concern since the onset of the Greek debt crisis in St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015ority of holders without the debtor country resorting to measures that rely on sovereign powers in one form or another. Gulati and Zettelmeyer define the 'principle of voluntariness' as the promise (explicit or implicit) to continue paying creditors regardless of whether they take part in a restruct St-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015uring or 'hold out.' They call for giving up the current 'fixation with 'voluntary' restructurings'.9 No sovereign debt restructuring in response to aSt-Marys-School-Moscow-FINAL-SELF-STUDY-DOC-2015
fundamental debt sustainability problem is ’voluntary' in the sense that creditors are only paid part of their promised consideration, under the exprGọi ngay
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