The ISDA Emperor Also Has No Clothes

Writing down sovereign debt by over 50% and subordinating one class of bondholders from another, those being the royalty ensconced within the European Central Bank, would not qualify as a “credit” event, now would it?

No way!! Of course not!! Why would it??!!

Not when those compelled to pay out on the supposed “insurance” within derivative contracts are the royalty within other large international banks and they sit in the positions of judge, jury, and counterparty in the case.

Welcome to the world of international finance circa 2012. 

The ‘case before the court’ has to do with the restructuring of Greek sovereign debt and the fact that certain bondholders will take a very sizable haircut while others, primarily the European Central Bank, will not.

Would the holders of ‘insurance’ in the form of CDS (credit default swaps) collect payment on those swaps which would largely offset the writedown in the value of their bond holdings? Welcome to the arcane world of the International Swaps and Derivatives Association (ISDA), which promotes itself as,

Since its founding in 1985, the International Swaps and Derivatives Association has worked to make over-the-counter (OTC) derivatives markets safe and efficient.

ISDA’s pioneering work in developing the ISDA Master Agreement and a wide range of related documentation materials, and in ensuring the enforceability of their netting and collateral provisions, has helped to significantly reduce credit and legal risk. The Association has been a leader in promoting sound risk management practices and processes, and engages constructively with policymakers and legislators around the world to advance the understanding and treatment of derivatives as a risk management tool.

Today, the Association has more than 815 members from 58 countries on six continents. These members include a broad range of OTC derivatives market participants: global, international and regional banks, asset managers, energy and commodities firms, government and supranational entities, insurers and diversified financial institutions, corporations, law firms, exchanges, clearinghouses and other service providers.

ISDA’s work in three key areas – reducing counterparty credit risk, increasing transparency, and improving the industry’s operational infrastructure – show the strong commitment of the Association toward its primary goals; to build robust, stable financial markets and a strong financial regulatory framework.

Sounds impressive but then again, “talk is cheap” and “words mean little” if the ISDA ‘emperor’ cannot perform. Let’s navigate further.

In regard to the situation in Greece and this restructuring, the members of the ISDA committee released the following statement,

The EMEA DC determined that it had not received any evidence of an agreement which meets the requirements of Section 4.7(a) of the 2003 Definitions and therefore based on the facts available to it, the EMEA DC unanimously determined that a Restructuring Credit Event has not occurred under Section 4.7(a) of the 2003 Definitions. (LD’s highlight)

Granted there is little real surprise in this announcement as market participants have come to expect the ongoing charades within the international banking arena to continue. That said, for the record, let’s listen to what selected market participants had to say. The FT sheds real insight this morning in writing, No Insurance Pay-Out on Greek Debt,

Paul Griffiths, global head of fixed income at Aberdeen Asset Managers, said: “This may be bad news for the CDS market. In the longer-term, there is an almost metaphysical question. Why is CDS there? Why does it exist? “

Is this CDS market and the ISDA simply for institutional bondholders and heavyweights in the world of global finance? Do you own an international bond fund? Don’t think for a second we are not all impacted by the charades being played. We all eat the costs distributed.

While the risks of these charades may currently be disguised by the liquidity injected by global central banks, the risks and accompanying costs accrue and extend for future generations. To that end, the ISDA emperor has also been shown to have no clothes and joins with other regulatory bodies in being neutered by the titans of finance.

What does this all mean? Are the CDS contracts worth the paper on which they are written? What’s that you say? Does somebody in the back of the room have a comment? Please speak up so we can all hear…

Navigate accordingly!!

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

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