Sellers of credit-default swaps on Greece may have to pay 78.25 cents on the euro to settle contracts triggered by the nation's debt restructuring.
Dealers set an initial value of 21.75 percent at an auction for Greek bonds today, according to administrators Markit Group Ltd. and Creditex Group Inc. The auction is being held under the rules of the International Swaps & Derivatives Association and a final rate will be determined at 3:30 p.m. in London.
Greek credit-default swaps are being settled after investors were forced to exchange their bonds at a loss in the biggest ever debt restructuring. The auction ends more than two years of speculation over whether the derivatives are viable for insuring sovereign debt after European policy makers sought to prevent payouts on concern they'd worsen the region's crisis.
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"The fact that it works means it can remain a viable hedging instrument and used for trading purposes as well," said Elisabeth Afseth, an analyst at Investec Bank Plc in London. That's important because "the product is there as a hedge for other sovereign investors, and significant risk remains in Europe."
Sellers of protection will pay buyers face value in exchange for the underlying securities or the cash equivalent. The results of the auction are posted on Creditfixings.com, a website run by Creditex, a New York-based derivatives broker, and financial information provider Markit.
There were 4,369 outstanding swaps contracts insuring a net $3.2 billion of Greek debt as of March 9, according to data from the Depository Trust & Clearing Corp., which runs a central registry for the market.
Greece was stripped from the Markit iTraxx SovX Western Europe Index last week, causing a drop of about 100 basis points in the measure of government debt risk. The gauge, which now includes swaps on 14 nations, was trading at 225 basis points today.
"Triggering CDS might have more positive than negative implications for European government bond markets," said Ioannis Sokos, a fixed-income strategist at BNP Paribas SA in London. "It's a clear demonstration that there is a functioning hedging tool out there for holders of other peripheral bonds."
Investor concern that Portugal will follow Greece in seeking to reduce its debt burden by imposing losses on private bondholders has driven up the cost of insuring $10 million of that nation's debt for five years to $3.6 million in advance and $100,000 annually. The price of credit-default swaps signals a 66 percent chance of default, according to CMA.
Former European Central Bank President Jean-Claude Trichet led opposition to triggering Greek swaps on concern traders would be encouraged to bet against failing nations and profit from the region's sovereign debt crisis.
In Greece's restructuring, investors were forced to write off more than 100 billion euros ($132 billion) of debt in return for new bonds worth 31.5 percent of their original investment. Contracts wouldn't have been triggered if the debt exchange had been voluntary, according to ISDA's rules.
"If Greece and EU authorities had invalidated the reason for existence of CDS contracts, this could create selling pressures on other peripheral bond markets," BNP's Sokos said.
Bloomberg News
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