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The ISDA of March

Thursday March 1st 2012

Looking at the results of the 2nd ECB 3 year LTRO programme one can note 2 distinct points of interest.
The forecast range of capital requirement was from EUR200Bn to EUR1Tn. So given that the actual allocation of funding was EUR529.5Bn we should not worry about the amount.
What is a concern is that the number of banks that applied for access to the facility was 800, well above the 523 that participated in LTRO 1.0. 
Given that the naked ambition of the LTRO programme is to stave off a liquidity lapse within the Euro Zone banking system, what is clear from yesterdays action is that many banks within the Euro Zone remain light on their level of capital adequacy. Given that, it is highly likely to see the Euribor-OIS spread creep higher if it is felt that certain banks are still in fragile financial form. The difference between EURIBOR and overnight indexed swaps, was 64bps yesterday, the lowest since August 31st and down from 97bps at the start of the year.
The reality is that the facility has generally staved of an immediate crisis, but the money taken by banks once the balance has been adequately beefed up is simply being parked in the front end of the Euro Zone sovereign curves. The short dates issued by governments are being taken as convenient cash cow vehicles until banks have to honour their own obligations due in 2012 and 2013. Currently there is little activity at the long end of the curve and the money raised via the LTRO 1.0 or 2.0 is not seeking its way into the real economy.
The International Swaps and Derivatives Association, (ISDA) i.e. the global authority that regulates the sale and use of credit default swaps (CDS) is meeting today to discuss whether Greece’s debt swap should be considered a default, or “credit event”. there is no schedule for an announcement, however, we do expect to hear a decision by Monday, March 5th. ISDA did say that the act of including a collective action clause (CAC) would not in itself trigger an event...but their implementation would pave the way for a payout on outstanding Greek CDS contracts as a credit event will have been seen to have occurred.
One has to be clear as to what would happen if the ruling from ISDA is that an event has occurred. There will be no immediate move to effect the CDS contracts, in reality it will be  2 months from when a credit event is declared and final settlement of the Greek CDS contracts. Clearly for many this will be seen as being far from satisfactory as doesn't this imply that the financial framework is flawed. Why should a period of 2 months elapse before payment is due? There has been enough signposting that such an event was rapidly increasing in probability so the prospect of Greece defaulting and then a messy process of paper pushing being the aftermath is far from desirable.
It is now the 1st day of March...in 19 days time Greece has to produce EUR14Bn in coupon and maturity payments...the clock is ticking  and  should old Greek debt not be  exchanged for new bonds on that day one can reasonably expect an extremely sloppy and untidy outcome to follow.  Chaos will rear its head in that if no settlement is struck by March 20th, the market will be spooked and the next in line, i.e. Portugal will take a hit. Today the 10 year yields 13.74% cf. 1 week ago 12.46%.
For each EUR1,000 of old Greek bonds converted to new bonds the face value will be a paltry EUR315. In fact those same bonds are going to tumble to trade at 30% the stated face value, i.e.  the new Greek-bond component of the exchange will be worth about 10 cents for every Euro in face value of old Greek bonds that you might currently hold. Of course one has to factor in a token payout from the EFSF of 15% so the end result is a net haircut of 75%. there is no way this can be classified as a voluntary deal.
One may ask why Spotlight is raking over this ground again? Well one has to ask what will happen on March 20th because at the heart of the 2nd bailout is a deep mistrust of Greece by the European Commission and its ability to implement reform. That is why Luxembourg’s Jean-Claude Juncker, the leader of the Euro Group has called an European Union commissioner to take charge of rebuilding the economy in Greece. Greek Prime Minister Lucas Papademos rejected a call to appoint a special European Union official to oversee Greece’s economy,
Papademos said the program for Greece “would be implemented by the Greek government and the Greek authorities.”
Tick-Tock-Tick-Tock   time is running short!

Stephen Pope

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