A threat of new financial crisis looms after the International Swaps and Derivatives Association classified the debt swap deal between the Greek government and private sector lenders as a ‘credit event’,triggering insurance payments running into billions of dollars.
The ISDA said a “credit event”,or a technical default,has occurred because the Greek government activated the Collective Action Clause (CAC) in its bond contracts to force the participation of those bond-holders who have not signed up for the deal.
This would mean that insurance against bond losses called Credit Default Swaps (CDS) would have to be paid out.
European politicians and financial authorities are worried that payment of CDS could destabilise the financial institutions that sold them and could set off a chain reaction as happened in the aftermath of the collapse of the US investment bank Lehman Brothers in 2008.
Insurance giant American international Group had to be bailed out by the US government after it could not meet the insurance payments for CDS on mortgage debts in the collapsed US property market.
“The coming weeks will show whether the European financial institutions will be caught up in an avalanche of insurance claims,” a banking expert said.
European governments have been trying to avoid a “credit event” by pressing Greece’s bond-holders to participate voluntarily in a debt restructuring.
However,the Greek government announced on Friday that it had activated the CAC to achieve its goal of 96 per cent participation by its lenders in writing down up to 53.5 per cent of their claims in nominal terms so that its privately-held debt of 206 billion euros can be halved.
This is a condition it has to fulfil to receive the second bailout package of 130 billion euros offered by the European Union and the International Monetary Fund (IMF).
Greece urgently needs the assistance to avoid a default on repaying 14.5 billion euro debts due on March 20.
Until the deadline set by the government for a voluntary participation by its private lenders expired on Thursday night,85.8 per cent of investors agreed to exchange their existing bonds for new ones with less value,lower interest rate and longer maturity of 30 years. Therefore,activation of CAC became necessary. The government had passed a legislation in February empowering it to use the clause.
The ISDA had earlier said it was not treating the Greek debt write-down as a “credit event.” But it changed its decision on Friday because following the Greek government’s activation of CAC,”the right of all holders of the affected bonds to receive payments has been reduced,” it said in a statement.