How the Greek debt reorganisation of 2012 changed ... - Allen & Overy

34 How the Greek debt reorganisation of 2012 changed the rules of sovereign insolvency – September 2012
Derivatives Association are (1) failure to pay,
(2) repudiation/moratorium, and (3)
restructuring. All of these have very detailed
and technical definitions.
Thus, if a credit event occurs and the value of a
100 bond is now 20, then the seller of
protection must pay the buyer of protection 80,
so that the buyer of protection ends up with the
full 100. Unlike an ordinary guarantee, the seller
of protection does not then take over the whole
bond by way of subrogation because the seller
of protection does not pay the whole bond. In
addition, the seller of protection does not have
a right of indemnity against Greece as the issuer
– a right which a guarantor would have.
Bondholders who buy credit protection are
likely to want a credit event to happen.
There is a separate Intelligence Unit paper of
October 2011 entitled Sovereign state restructurings
and credit default swaps which contains a
description of credit default swaps and a
detailed analysis of the typical sovereign credit
events.
The politics of a restructuring credit
event
The eurozone was initially very reluctant to
contemplate the occurrence of a credit event in
relation to Greece. Presumably, officials
thought that a credit event was likely to be
perceived by the market as a default and likely
to affect the future credit ratings of Greece.
Some sovereign states had hostile views on the
credit default swap market, which they blamed
for publicising and exaggerating their financial
woes. Some commentators may have regarded
credit default swaps as exotic speculation
mainly carried out by evil hedge funds
determined to profit from the misery and
misfortune of others, a view perhaps more
consistent with the thirteenth century in
Europe than the twenty-first.
The attitude of regulators tended to depend
upon who they thought were the ultimate
beneficiaries of the credit default swap and
who, ultimately, would have to pay. If they
thought that banks’ exposures would be
© Allen & Overy LLP 2012
reduced by credit default swap protection, and
if they thought that banks were not sellers of
protection, then they would favour the
crystallising of a credit event. A default by a
significant sovereign state could have had
serious repercussions for the banking system
and could, in the worst case, have resulted in
threats to financial stability and another
financial crisis. Banks are very vulnerable to
contagion effects and the falling of one domino
can knock down the others so as to give rise to
a systemic crisis. Regulators were sensitive to
the systemic consequences of credit default
swaps partly by reason of the disasters
experienced by the United States-based
insurance group AIG in 2008.
If, on the other hand, the regulators thought
that the sellers of protection were largely banks
as well, then their attitude was likely to be
different: they were unlikely to favour the
crystallising of a credit event.
Greece credit events 2012
Whether or not there has been a credit event is
decided quickly by an ISDA Determinations
Committee which also calls for an auction to
determine the market price.
On 9 March 2012, a Determinations
Committee decided that a forcible exchange of
existing bonds for new bonds, and the
additional consideration by Greece’s
implementation of the new collective action
clauses, was a restructuring credit event in the
case of the Greek law bonds because the
exchange was not voluntary and because the
existing bonds were cancelled by statute. In
substance, the existing bonds were changed.
In the case of foreign law bonds, there was a
voluntary exchange, but the existing collective
action clauses in the bonds were implemented
by Greece with the result that all bondholders
of each series, which were bound by a
successful amending resolution, received new
bonds and other consideration, and the
resolutions reduced the amounts payable on the
existing bonds to zero. This was a restructuring
credit event.