Greece Default Swaps Failure to Trigger Casts Doubt on Contracts as Hedge

As a result of labeling 50% haircuts 'voluntary', Credit Default Swap contracts have proven to be useless when it comes to protecting against sovereign default. The serious implication is investors will need to find another way to hedge.

Bloomberg reports:

The European Union’s ability to write down 50 percent of banks’ Greek bond holdings without triggering $3.7 billion in debt insurance contracts threatens to undermine confidence in credit-default swaps as a hedge and force up borrowing costs.

As part of today’s accord aimed at resolving the euro region’s sovereign debt crisis, politicians and central bankers said they invite Greece, private investors and all parties concerned to develop a voluntary bond exchange into new securities. If the International Swaps & Derivatives Association agrees the exchange isn’t compulsory, credit-default swaps tied to the nation’s debt won't pay out.

This will raise some very serious question marks over the value of CDS contracts.

If they find a way to avoid a trigger event in the CDS, then people will doubt the value of credit-default swaps in general, leading to more dislocations in the market

It punishes the banks that were well-hedged and managed, and bank hedging desks are definitely now trying to re-evaluate their use of default swaps.

More: [link to www.bloomberg.com]