Monday, November 21, 2011

The Rigged Sovereign CDS Market

Many have suspected that the European sovereign CDS market is rigged, but it has now been made absolutely clear. As Greek debt gets written down by 50% one would expect a payout on the CDS insurance. However the ISDA Determinations Committee, who decides on what constitutes a “credit event” that would trigger CDS to pay, has been saying that because the Greek restructuring is “voluntary”, there will be no payout on the CDS. Well if someone faces a choice of 50% or full default, they would probably choose the 50%. Is that really voluntary?

This morning’s NY Times talks about BNP Paribas' (French bank) role in Greek restructuring. The bank had been hired by the Greek government to help them build “consensus” (more like scare bond holders) among the bond holders to “accept” the 50%. An employee of BNP Paribas at the meetings with the holders openly admitted that she is in fact on the ISDA Committee. Clearly if you are a bank being paid by the borrower to do debt restructuring, you would want to make sure it’s not an event of default. And it’s no secret how they will vote on the ISDA Committee. Just a slight conflict of interest here.
One of the money managers who attended the meetings said Ms. Yang’s presence seemed to raise a conflict. Ms. Yang works for BNP, which stands to profit from the restructuring. She is also on the I.S.D.A. panel, which will determine if credit default swaps pay off.

One of the money managers said he pointed out Ms. Yang’s dual role at a meeting. “You’re on the determinations committee, your firm is earning a big fee and trying to scare me into tendering my bonds,” he said he told her. He said Ms. Yang replied: “No, I’m just trying to help tell you what could go wrong.”
Between the rigged settlement process and bizarre Eurozone CDS regulations that are about to get implemented (more on that later), the sovereign CDS market is dead. And with it will go the liquidity in sovereign bonds.
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