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Q&A: Greece’s ‘credit event’ and ISDA

International Swaps and Derivatives Association governs a market worth more than 0tn (£439tn), more than ten times the size of the global economy – but why is it in the news?

What is the ISDA?

The International Swaps and Derivatives Association is the industry body for the murky world of complex financial instruments. Despite the feeling that these things only cropped up yesterday, it’s been around since 1985.

Why is it important?

It governs a market worth more than 0tn (£439tn), more than ten times the size of the global economy. Part of that market is made up of credit default swaps (CDS), a sort of insurance contract against a country or company defaulting. These have shot into the limelight as Greece teeters on default.

Why is ISDA in the news?

ISDA is holding a conference call on Wednesday to discuss whether the deal to cut Greece’s debt constitutes a “credit event” – effectively a default.

If it does, that would lead to the payout of billions of dollars to the holders of .2bn worth of Greek CDS.

When will we hear their response?

The committee has until Monday to announce a decision. In the past, it has tended to take the full three days to decide.

What is likely to happen?

Market insiders expect ISDA to call a credit event. If holders of Greek debt all agreed to the debt swap, which sees their holdings cut in half, then its decision would almost certainly have gone the other way. However, Athens has included a Collective Action Clause in the deal, which would force creditors that did not want to swap the debt to do so. The ratings agency Standard & Poor’s has already said it would consider this to be “selective default”.

Could anything go wrong?

Quite a lot. After a default, a CDS auction is held to determine how much insurance should be paid out. This is based on the price of the lowest Greek bond. So, if Greek debt was trading at 25 cents to the dollar, the CDS would pay out 75 cents to the dollar. However, the auction process can take up to a month, by which time there will be none of the original Greek debt left because of the bond swap.

So?

If the amount of insurance paid out is not connected to the risk, the credit default swap market is in big trouble. Because if CDS don’t protect against a default, there’s very little point in holding them.

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