In a vast over simplification, CDS are a hedge (insurance)
against defaults on financial instruments. For a fee one can write or buy a CDS against - for this
example - a bond.
If the bond defaults, the seller assumes ownership for the
debt instrument and pays the holder a predetermined amount of cash. It is up to the new owner of the debt
instrument to work with the defaulted instrument to make a recovery. In short, for a fee paid by the owner
of the bond they transfer the risk of default to another party.
CEMEX was one of the first defaults to occur, as it was a
restructuring not a “default”.
Greece is restructuring in a voluntary move that is not a
“default”. Now we have Seat Pagine
Gialle - who has missed a bond interest payment.
The problem is what is a default?
I can tell you if you fail to make your mortgage payment on
time - that is a default. If you
fail to make your car payment - that is a default and an opportunity to learn
to ride the bus. Debt restructuring has been removed as a CDS trigger “credit
event” in the U.S., however it remains common in other countries where the use
of bankruptcy court to reorganize is less common.
Cemex debt was finally valued at .92 so CDS obligors had to
pay .08. Greek CDS was a forced
agreement - not triggering CDS, but if the banks had no coverage why bother to
the expense of buying a CDS to hedge?
Now with Seat Pagine Gialle , they have missed an interest payment and
the ISDA - the industry governing body over the CDS market - has said this is
not a “credit event”. There is a
provision in the bonds giving Seat Pagine Gialle 30 days to cure a default. Thus - by definition missing an interest payment is a
default - a credit event.
These CDSs remind me more and more of bad insurance
companies , you know - the ones
that say you are covered until you have an accident. Thus it appears to this investigator that CDS are an ephemeral
product real only on the day of contract and gone there after - similar to the
emperors new clothes.
The ISDA is composed of insiders to the market and the Determination
Committee of the ISDA are the insiders of the insiders.
Auditors now need to consider if CDS are really a hedge
against volatility and default or just an expense with no equitable
transference of risk. The pattern
of weaseling out of “credit events” - or significantly postponing settlement -
is getting to be all too common.
A true independent determination will need to be established
for CDS credit events. The body will need far removed from the insiders of the
CDS industry. Failure to make a
new authentic distinction on
credit events may have the CDS industry founder on the assumption that CDS are
hoax contracts - an insurance contract against which - one can never prosecute