Greek Swaps Sellers to Pay $2.5 Bln

Sellers of credit-default swaps on Greece will have to pay as much as $2.5 billion to settle contracts triggered by the nation's debt restructuring.

The settlement was determined after dealers agreed a final value for Greek bonds of 21.5 percent of face value at an auction, according to administrators Markit Group Ltd. and Creditex Group Inc., and is in line with where the notes have been trading.

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 reliable 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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"Markets may bounce after the smooth settlement in spite of fact it should have been expected," said Peter Tchir, founder of TF Market Advisors in New York. People were too worried about "the potential for a daisy chain of counterparty defaults — in spite of how unlikely that situation was," he said.

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. Ecuador was the last government to default and the first to have its debt auctioned in 2008.

"The fact that CDS works means it can remain a viable hedging instrument and be 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."

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 220.5 basis points today. Cyprus will be added to the index when it rolls into a new series tomorrow, Markit said.

"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.

Trichet Opposition

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.

Traders were anticipating a swaps payout of about 80 cents, based on the price of Greece's new 30-year securities.

It's "fortunate" that the price of the new bonds is "almost exactly the same" as the bonds that were exchanged, according to Michael Hampden-Turner, a strategist at Citigroup Inc. in London. The swaps payout might have been smaller if the new bonds had a higher face value, he wrote in a March 16 note.

"The result was something of a lucky break," he wrote.

Bloomberg News

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