Tomorrow is the ultimatum for Greece’s private creditors, as they must decide whether to accept the “voluntary” haircut on their bondholdings. To cut a long story short, if they accept the deal they will receive unattractive, long-dated, low-interest bonds for roughly 30% of face value. Should creditors decline the deal however, Greece’s government is going to enforce Collective Action Clauses (CACs) which will force creditors to accept the terms.
So what, you say? Anyone with any sense would have dumped their bonds ages ago, and those who do hold them have largely written them off. The reason why this matters is how this “voluntary haircut” is seen by the ISDA (International Swaps and Derivative Association) with regard to CDS (Credit Default Swaps). If the CACs are activated by the Greek government, then the ISDA is expected to see it as a default – and deem that the insurers of CDS must pay out. On the other hand, if the haircut is accepted by creditors, then the CDS will not pay out.
So tomorrow is a crisis point, and the way things are looking the CACs will come into play. I am unsure of the threshold for the CACs to be enforced, but I think it is 66% of bondholders, and as of this afternoon, only 39.3% had agreed.
The problem is that nobody is certain that the ISDA will behave in this manner. In fact, if they do declare payouts, the insurers are likely to fight tooth and claw in a long legal battle to not do so. If the ISDA do not, then the parties who have insured their debts are likely to have an equally long and laborious legal battle on their hands.
The fact of the matter is, if losing 70% of your investment doesn’t count as a default, then what does? Many banks, hedge funds and investors have insured their investments with CDS and if they won’t be paid out on the Greek deal, then surely they won’t be paid if other Eurozone nations go belly up. If CDS fail to deliver, then the instruments will become redundant and fears of contagion will spread across peripheral Europe as investors will flee their positions. Bond yields will rise in the periphery, the value of those bonds will fall, resulting in major harm to Europe’s financial sector.
Wranglings about CDS, the risks of the Eurozone breakup and a potential meltdown, would make you think that the market would crash. But no, the FTSE 100 last week almost hit 6,000 and has only retreated slightly since that point. The markets seem to have totally underestimated the severity of this Eurozone crisis. If investors lose faith in Italy and Spain then we’re heading towards Armageddon scenario.
At 8:00 AM tomorrow morning sell all the shares you own. Short-sell the FTSE 100. I may of course be wrong, this process may be a slower than estimated – but it would seem that the market is a captain aware of the stormy waters ahead, but complacently sailing into them. A wreckage is not far away.