ISDA has made the right decision: the Greek bond default does not and should not count as a “credit event” for the purposes of whether Greek credit default swaps will get triggered.
As Felix rightly points out, if you take a 21% haircut on your bond principal and can’t call that a default, what good is CDS protection?
A few years ago, just about every reinsurance broker in the world (us included) was looking at CDS as a way of hedging insurers’ exposure to reinsurance recoverables in the event of reinsurer insolvency. It only took a few days’ work to realize the whole thing was useless.
The problem in insurance is that reinsurers don’t go into ‘default’. They go into something called “run-off”.
Insurer obligations are fundamentally negotiable. If an insurer declares itself ‘in runoff’ (ie it is accepting no new business) it has signaled its financial weakness and warned claimants that the pot might run dry before they get paid. Suddenly a claimant will accept 0.80 on the dollar for fear of getting even less later.
Well, that improves the solvency of the insurer but the people owed money get screwed.
Bankers tend to feel pretty smug about their black-and-white default definitions because the cross-default provision lets most lenders push the big red button when they get miffed. Looks like the Eurocrats have got that one sewn up somehow, though. Oops.
All anyone really wants is protection against principal reductions on what’s owed ’em. Throw in a bit of relief from the legal nonsense of squeezing your last few pennies out and you’ve got yourself a product.
Problem is, this is a product that doesn’t exist. In any financial market, it seems.