For the Greek debt debacle to truly wreak havoc, the International Swaps and Derivatives Association must follow in the footsteps of rating agency Standard & Poor's and declare Greece's debt restructuring an effective default.
So far, there seems little chance that current proposals for a second bailout will prompt such a move by the global organization.
"As I understand it, the French plan is effectively a voluntary rollover, and generally speaking a voluntary rollover wouldn't trigger [a default]" the ISDA's general counsel David Geen told Reuters on Monday.
ISDA oversees the market for credit default swaps - insurance contracts that protect against defaults. It decides when insurers are liable and must pay out. In other words, Greek bond investors who bought credit default swaps will collect only if the ISDA agrees that Greece has defaulted.
That has implications for the broader market because a similarly tangled web of credit default swaps almost brought down the global financial system after Lehman Brothers filed for bankruptcy in 2008.
Unlike stocks, which are publicly traded on central exchanges, credit default swaps are contracts negotiated between two parties. When Lehman went bankrupt, sorting through the contracts took months. Worse, insurers had written more insurance policies against Lehman than they could afford to pay out.
While the financial crisis in Greece is not as murky, it does hold similar implications for insurers. While some observers believe banks and insurers could withstand a default on the country's €330-billion ($460-billion) debt, markets would fall because liable insurers would immediately record huge losses, sending their stocks plunging.
Although rating agencies have been criticized in recent years for their failure to predict the U.S. housing crisis or warn of problems facing financial institutions during the recession, many portfolio managers and pension funds are bound by their ratings. For instance, some money management firms are restricted to bonds of a company or country whose issues are rated as investment grade by the agencies.
And that means even if the overall market is in good shape, a downgrade sanctioned by ISDA would force many holders of Greek bonds to sell.Report Typo/Error