Market Overview

Goldman Sachs, JP Morgan, Other Big Banks Deciding Fate of Greek CDS's

The International Swaps and Derivatives Association (ISDA) ruled today that the latest debt swap arrangement, which imposes a 53.3% haircut on the Greek bonds, is not a "credit event" that will trigger the credit default swap contracts. Essentially, this means that the investors, who had bought insurance on the Greek debt, will not get paid at this stage in spite of over 50% reduction in the value of bonds.

The decision board notes in its the report though that "the situation in the Hellenic Republic (Greece) is still evolving and today's EMEA DC decisions do not affect the right or ability of market participants to submit further questions to the EMEA DC relating to the Hellenic Republic nor is it an expression of the EMEA DC's view as to whether a Credit Event could occur at a later date, in each case, as further facts come to light."

This leaves room for a credit even to occur in the future as soon as next week, when Greece might have to use its new legislation to force private creditors to approve the debt restructuring. However, investors might be surprised to find out who actually makes the credit event decision. Especially, those investors who were expecting an impartial board might find themselves stunned.

According to the ISDA website, the EMEA region decision board consists of:

Voting Dealers:

Bank of America / Merrill Lynch (NYSE: BAC), Barclays (NYSE: BCS), BNP Paribas, Credit Suisse (NYSE: CS), Deutsche Bank (NYSE: DB), Goldman Sachs (NYSE: GS), JPMorgan Chase Bank (NYSE: JPM), Morgan Stanley (NYSE: MS), Societe Generale, and UBS (NYSE: UBS)

Consultative Dealers:

Citibank (NYSE: C) and Royal Bank of Scotland (NYSE: RBS)

Voting Non-dealers:

BlueMountain Capital, Citadel, D.E. Shaw Group, Elliott Management Corporation, and PIMCO

Several institutions that could underwrite the Greek credit default swaps or trade them also decide whether they get triggered. Evidently, this creates a potential conflict of interest, especially, if the deciding institutions are liable for a significant amount of CDS's.

Credit default swaps raised a lot of criticism during the financial crisis in the United States due to their lack of transparency and potential to create a systemic risk to the economy. Hence, the fact that they are now regulated by the large banks that initially created these derivatives might not make an average investor feel more comfortable about credit default swaps. In fact, retail investors may want to stick to securities, such as equities that are regulated by institutions that do not have their own money on the line.

You can follow me on Twitter @TuomoKallio

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