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 a claim.