Crisis in Greece Leads to Renewed Calls for CDS Regulation


Greek Prime Minister George Papandreou urged global action to curb speculation in credit default swap (“CDS”) transactions, particularly those relating to sovereign debt. During a visit this month to the United States, Papandreou said: “We need clear rules on shorts, naked shorts and credit default swaps. I hope there will be a positive response from this side of the Atlantic to bring this initiative to the G20.” At a joint news conference with German Chancellor Angela Merkel in Berlin on March 5th, he also referred to CDS as a “scourge” that threatened the Greek and global economies. Merkel added: “Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb.”

Fear of contagion from Greece’s fiscal troubles have led to concern across the European Union, particularly in the eurozone. In an effort to calm market concern over its spending, the Greek government passed extreme austerity measures in early March, including a sharp cut in civil servant entitlements and an increase in the value-added tax rate. These measures are intended to result in savings of some €4.8 billion. But Greece remains in desperate need to access the capital markets as well, as it must roll over €53 billion of its approximately €300 billion of debt this calendar year, €20 billion of it by the end of May. The sixteen eurozone members remain divided on whether—and how—to assist Greece. Concerns exist over the prospect of their failure to provide standby loans or other support to Greece, which could harm the credibility of the Euro if Greece instead seeks support from the International Monetary Fund. Additional pressure for a solution was put on eurozone members by the March 24th downgrade of Portugal’s debt rating to “AA-” from “AA” by Fitch Ratings.

As the Greek debt crisis has unfolded, the country’s borrowing costs have skyrocketed. On March 4th, the country issued €5 billion of heavily-oversubscribed 10-year bonds at 6.25%, or approximately twice the rate payable on German bunds. Papandreou and some commentators blamed this 300 basis point premium over the German benchmark, at least in part, on speculators buying protection through CDS contracts. The purchase of such protection by speculators effectively bets on a default on debt which, in turn, drives up CDS premiums and reinforces the market perception that Greece will indeed default; this negative market perception is reflected in the borrowing costs of bonds issued. Of course, the primary driver of Greece’s high bond rate is the inherent risk of its ability to repay its debt.

Despite substantial industry efforts to increase standardization and transparency for CDS in the wake of the AIG crisis,[1] the product remains viewed by certain vocal critics as a major contributing factor to the financial meltdown that should be subject to stricter regulation, or even outright ban. Indeed, the Greek crisis has led to renewed calls for regulation and bans of the product across Europe, including by Jose Manuel Barroso, the European Union Commission President. This spotlight shines on CDS as comprehensive financial reform legislation continues to be considered by federal legislators in the United States and in the European Union.

[1] CDS transactions were subject to condemnation by politicians and the media alike in connection with the AIG crisis in the fall of 2008. Among other things, this crisis led to a short-lived effort by New York State insurance regulators to make certain CDS transactions (i.e., those under which buyers of protection own the underlying asset on which protection is written) subject to insurance regulation (see Client Alerts: September 2008 and November 2008). More recently, the New York Senate released draft legislation this month under which, among other things, certain credit protection sellers would need to be licensed as providers of “credit default insurance.” It is not clear whether this proposed legislation would be redundant with (or be precluded by) any final federal regulation of CDS.