Monday, July 25, 2011

Debt Limit and Credit Default Swaps: ISDA Hedges

Reuters has an interesting article about credit default swaps on U.S. Treasury securities. In the event of a U.S. default on its debt, there are two areas where there is some confusion about whether CDS sellers would be required to pay according to David Geen, general counsel of the International Swaps and Derivatives Association ("ISDA"). The first is whether any grace periods apply, though apparently the contracts on U.S. Treasuries, unlike those on corporate securities, do not specify a grace period. ISDA is "researching" this issue.

The second issue seems totally imaginary. David Geen is quoted as saying: "In order for there to be a credit event there has to be publicly available information that says this payment was due on this day and it wasn't made, and that may not be that easy to demonstrate." One wonders what he is talking about. It will be very clear if Treasury misses a payment. For example, the Daily Treasury Statement details payments day by day, if one did not want to rely on other Treasury press releases and the statements of holders of Treasury securities that they had not received interest.

I am sure it is reassuring to buyers of CDS on Treasuries that a committee of ten dealers and five asset managers will make the determination about whether payments need to be made in the event of a Treasury default.

There is also an issue about CDS on Greek debt. You have to wonder what the point of buying a CDS is if the contracts are this murky.

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