Debt Plan Could Deny Those Who Bet on Default By LOUISE STORY and JULIE CRESWELL Published: October 27, 2011
The naysayers who have been betting against Greece may not get their big payoff.
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Jin Lee/Bloomberg News Michael Greenberger says investors betting against Greece are “gaming the situation.”
That is because even though Greece is not going to pay all its bills, it intends to avoid a debt default.
And many investors have bet against Greece, using billions of dollars in complex financial instruments, called derivatives, that turn a profit when there is a debt default.
Worried about the ripple effects of any such default, European leaders announced on Thursday a plan for a voluntary swap of Greek debt. Holders of Greek bonds are being asked to accept a loss of at least half the face value of their bonds and will in exchange receive certificates guaranteed by the countries in the euro zone. If enough investors accept this deal — and that is uncertain — Greece will avoid a default and the derivatives contracts will not pay out.
The determination of a default in the derivatives market is not up to regulators. A committee of an industry association decides after a market participant asks for a ruling. Market participants are waiting to see if the voluntary swap is successful. The association, however, provided guidance on Thursday that a voluntary swap would not constitute a default.
Ever since Greece ran into problems, European officials and banks have been at odds over derivatives on sovereign debt. The business is profitable for the institutions that create the products, but some officials fear that the trading of the contracts has helped feed the crisis.
Derivatives have been among the most lucrative banking businesses for more than a decade. Companies like JPMorgan Chase, Goldman Sachs and Deutsche Bank have sold trillions of dollars worth of derivatives that, like homeowners insurance, promise to pay out in certain situations in exchange for a small premium. These financial instruments allow investors to make an outright negative bet against a country or to protect themselves against losses on investments in, for example, Greece.
Analysts warn that the derivatives market may lose some of its credibility, at least in the sovereign debt area, if the contracts tied to Greece do not pay out.
“If a 50 percent notional haircut doesn’t trigger an insurance contract on that debt, I mean what’s going to trigger it?” asked Antonio Garcia Pascual, chief economist for Southern Europe at Barclays Capital. “ If you bought protection and now all of a sudden, a 50 percent haircut is imposed on you and you don’t get a payout on your insurance, that really casts a large doubt.”
Still others say that European leaders are wise to try to stifle profits in the derivatives market to discourage additional speculation.
Investors who bought derivatives on Greece “are just gaming the situation,” said Michael Greenberger, a professor at the Francis King Carey School of Law at the University of Maryland and a former official at the Commodity Futures Trading Commission, which oversees derivatives in the United States.
Mr. Greenberger said if Greece’s derivatives did not pay out, traders might flee other derivative contracts on European countries and banks there.
“That’s like saying that people who have bets in Las Vegas will pull their bets,” he said. “It has a good social consequence. I’m all for people betting, but when betting leads to worldwide contagion, I think it needs to be stopped.”
Whether investors will really lose interest in derivatives on sovereign debt in Europe is unclear.
A lively market has continued for Greek derivatives even after European officials indicated in July that they would like to avoid a default by using a voluntary swap. Some investors say they believe that the voluntary deal will not succeed and that a default will ultimately follow.
“If you’re a bank and you have a lot of exposure and risk to Spain, you’re not going to exit,” just because Greece did not default, said Gennaro Pucci, who oversees the $500 million Matrix PVE Global Credit hedge fund in London.
Ultimately, representatives of a group of financial companies will declare whether a default has occurred. Those companies — 10 banks and five asset managers — are on a committee of the International Swaps and Derivatives Association, a trade group. The association does not name the individuals, but it makes their votes public afterward, listing them by company. The banks and investment firms do not have to disclose their financial interests.
A spokeswoman for JPMorgan Chase, one of the banks on the committee, said in an e-mail, “As a policy on these matters, we do not vote our book.”
None of the other companies provided a comment or replied to e-mail messages about the process. They include Morgan Stanley, Goldman Sachs and Bank of America, as well as European banks like UBS, Société Générale, Deutsche Bank, Barclays Bank, BNP Paribas and Credit Suisse. The asset managers are BlueMountain Capital, BlackRock, the Citadel Investment Group, D. E. Shaw and Pimco.
The I.S.D.A. rules have been used to declare a sovereign default only once— for Ecuador in 2008. The rules say debt swaps should be declared defaults if they are “binding to all holders.” The Greek swap is voluntary.
“At the end of the day, if people have the right to walk away, then that counts for a lot,” said Richard Metcalfe, the global head of policy at I.S.D.A. “People can step away if they like.”
A version of this article appeared in print on October 28, 2011, on page B1 of the New York edition with the headline: Debt Plan Could Deny Those Who Bet on Default . |
