Steering sovereign debt restructurings through the CDS quicksand

Abstract

A central policy concern since the onset of the Greek debt crisis in 2010 has been whether sovereign debt restructurings trigger credit default swaps (CDS). For the first time since AIG threatened to default on its CDS in 2008, the Greek debt crisis returned CDS to the global spotlight. The question of whether sovereign debt restructurings trigger CDS matters not only for the buyers and sellers of CDS, but for financial stability more generally. Although there was universal agreement that a failure to pay when due would trigger a failure to pay credit event under CDS, whether formally voluntary/restructurings also trigger a restructuring credit event was uncertain before the Greek debt restructuring in March 2012. On the basis of the experience with the Greek restructuring, this article assesses how likely five restructuring techniques, ranging from simple bond exchanges to the use of collective action clauses, trigger CDS.