October 29, 2011
The future of the Credit Default Swap (CDS) market -- used to hedge against the risk of a country defaulting -- may be at risk if these derivative instruments do not pay out after this week's rescue deal for Greece.
An implosion of the sovereign CDS market could lead investors to buy fewer government bonds because they feel they cannot protect themselves, and risks pushing up borrowing costs for governments, especially in the euro zone.
Private sector creditors such as insurers, banks and funds will take losses of 100 billion euros on their Greek debt holdings under a new bailout pact struck this week, sharing the burden of the costly rescue with taxpayers.
But the International Swaps and Derivatives Association (ISDA) -- a bank lobby that also decides whether an event triggers the CDS -- has said it's not likely that the restructuring would lead to a pay-out.
"The CDS market is being keelhauled. This certainly isn't going to help, because why would you buy a CDS if there will never be a payout?" said one well-placed industry source, referring to the Greek situation.
He projected the sovereign CDS market -- a small corner of the $25 trillion overall market -- could die out in the next year, echoing some bankers' fears.