As S&P has announced Greece’s debt to be in selective default, the dominos are starting to fall one by one. The Wall Street Journal reports that the European Central Bank has stopped accepting Greek bonds as collateral for loans. Tomorrow’s LTRO auction will be subject to ECB rules and presumably will box out Greek debt. We wonder if any Greek debt already at the ECB will have to be substituted?
Cash is still available for funding Greek debt through the Emergency Liquidity Assistance (ELA) program. The ELA allows respective country’s central bank to provide liquidity to their banks on assets the ECB wont take. S&P has implied that once the Greek restructuring is done, the selective default will be removed (allowing the ECB to take Greek debt again). The European Financial Stability Facility (“EFSF”), part of the next round of Greek bail-out funds, can be used to finance collateral, but it won’t be available until mid-March. Timing is everything and this timing couldn’t have been worse.
Meanwhile, ISDA is being pushed to form a Determinations Committee to review whether Greek CDSs should be paid out. Also according to the Wall Street Journal, “An unidentified market participant has asked a committee of the International Swaps and Derivatives Association to rule on whether the passage of legislation approving collective-action clauses for Greek debt should trigger payouts on credit-default swaps tied to Greek sovereign bonds.” Although two months ago this would have been a non-starter for the person making the request, now that S&P has officially put Greece in selective default there may be a different story.
ISDA had argued in the past that since Greek debt doesn’t include Collective Action Clauses (CACs), owners of debt who did not want to accept a restructuring could simply retain the original debt. And since the debt those hold-out investors owned was not modified, a credit event would not be triggered. But the Greek government just added CACs to their debt, so all bets are off. Any restructuring that is involuntary for any holder would be a credit event, triggering CDS.
For securities finance and collateral management professionals, the change in Greece’s status is really big news. First, it may instigate some basic changes in how the ECB charges for loans. The fact that the ECB has never differentiated between the bonds of EU member-states has created distortions in the repo market (see our Sept 3 2011 post on the matter here). If the ECB would begin to charge differently based on the credit worthiness of the national bonds it was taking in, there might be less mess now to contend with. Second, an ISDA Determinations Committee declaring that Greece is in default would launch a major payout on Greek debt. Third, while more pain may still be ahead, declaring a default would at least let Greece start to get its fiscal house in order, make deals with existing bond holders on payouts, and maybe not repeat its past errors. Finally, don’t forget about the First to Default (FtD) notes with Greece debt included as a reference entity. The Greek default forces an unwind for all the components and that selling pressure could escalate — think contagion. No one really knows how many of those are out there.
Need more details on ISDAs, Greece’s possible default for CSDs and what it all means? See Finadium’s The Credit Default Swap vs. Repo Trade released earlier this month.