Thinking about Sovereign Credit Default Swaps

The Depository Trust and Clearing Corp provides a central register for credit default. A recent report indicated that there are about $5 bln of outstanding Greek sovereign CDS. Greek debt in dollar terms is about $483 bln, meaning the CDS covers about 1% of Greece's sovereign debt. This is considerably smaller than one might suspect.

The size of the sovereign CDS market is much smaller than one might expect. Consider Italy DTCC says estimates its sovereign CDS market is about $25 bln. The outstanding debt is around $2.3 trillion. The corporate credit default swap market appears more developed. It is less unusual to buy credit default swap protection on corporate bond exposures than it is on sovereign debt.

There have also been examples of voluntary "reprofiling" in the corporate sector that did not trigger a CDS event. However, given the concerns already expressed by the rating agencies and the current sovereign rating outlook, structuring a Greek restructuring on a voluntary basis, though looks particularly difficult. Of the 85 bln euro of maturing Greek debt over the next 3 years, European officials acknowledge that the full amount cannot be expected to be voluntarily rolled over.

While recognizing that it is impossible to know a priori, European officials are hoping that the private sector "volunteers" to roll over about a 1/3 of the maturing debt. Given the ownership distribution of Greek debt (according to BIS and ECB figures), it is not unreasonable. However, in light the Merkel/Sarkozy joint position before the weekend, the market awaits the ECB acknowledgement and take. It can help its own cause and boost the chances of private sector participation, if it would agree to roll over it maturing Greek exposures too.

Trichet initially rejected such a proposal in his press conference earlier this month, but as we know the ECB has backed down before on what seemed like principled issues. Moreover, when the ECB began its controversial bond purchase program, it said it would hold them until maturity. This is unlike the US bond purchases, where no such commitment was made.

News out now that the ESM, the permanent replacement for the EFSF will not have preferred creditor status is an important development insofar as it removes an obstacle to the (eventual) return of the distressed sovereigns to the capital markets.