The Wilder View

CDS: Insurers Pay Only When the Bond Is ‘All Dead’

The saga that is the Greek CDS trigger – a credit event being ruled only after CACs were inserted retroactively and then used by the Greek government to force the debt swap – made me think of a classic scene in the Princess BrideWatch the YouTube clip of Billy Crystal as Miracle Max, who famously states that Wesley is only ‘mostly dead’:

“It just so happens that your friend here is only MOSTLY dead. There’s a big difference between mostly dead and all dead. Mostly dead is slightly alive. With all dead, well, with all dead there’s usually only one thing you can do….Go through his clothes and look for loose change.”

In the context of the Greece CDS market, CDS were triggered only after Greek bonds were deemed ‘all dead’. Going forward, will CDS insurers pay only when a bond is declared ‘all dead’, rather than being ‘mostly dead’? This does to some extent discredit the viability of CDS as a hedge. Bill Gross agrees, as reported by the FT, stating that the sanctity of the contracts have been challenged.

Historical data on gross CDS notional support Bill Gross’ views.

The chart above illustrates the percentage change in gross notional CDS contracts written (or bought) over the last year – 3/4/2011 to 3/2/2012 (see Table below for full representation of  European sovereign CDS market characteristics). The data are from the DTCC and available free to the public. I use Table 6 and include those sovereign credits listed by regional characteristic “Europe”. I chose gross rather than netted CDS exposure, as I view gross to be an appropriate proxy for the aggregate trend in market sentiment for CDS.

Some notable observations:

  1. Over the last year, the largest declines in gross CDS exposure occurred in markets insuring bonds issued by Portugal, Greece, Iceland, and Ireland. The largest increase in gross CDS exposure occurred in markets insuring bonds issued by Belgium, Slovenia, France, and Denmark.
  2. Of the top four gross notional declines, three countries are currently EU/ECB/IMF (Troika) program countries: Portugal, Greece, and Ireland. I surmise that the reduction gross CDS exposure in these markets is related to a loss in market confidence for CDS as a viable hedg.
  3. Iceland is an interesting case. I deduce that the reason for the decline in gross CDS exposure on Iceland’s bonds is not related to a loss in confidence of CDS as a hedge, rather improving credit fundamentals. In February, Fitch upgraded Iceland’s credit rating to investment grade.
  4. Italy and Spain saw an increase in CDS notional exposure over the last year, +7.7% and +2.3%, respectively. I expect that markets are cognizant of the fact that Spain and Italy are just too large for Troika to manage via PSI (private sector involvement). Therefore, CDS may still be deemed a viable hedge for Spanish and Italian bond exposure. Of note, the netted CDS exposure declined, indicating that some banks may not be hedging contracts written (see Table below).
  5. The vast majority of European CDS markets saw an increase in gross notional exposure. This is likely related to rising debt levels more broadly.


Triggering Greek CDS only after the use of CACs is the equivalent of declaring Greek bonds ‘all dead’ – beforehand, they were only ‘mostly dead’. Evidence demonstrates that markets are wary of this distinction between ‘mostly dead’ and ‘all dead’, and may reduce further CDS exposure the smaller markets where Troika interference is possible.

Rebecca Wilder

As a reference, the table below illustrates the full set of data available in DTCC Deriv/SERV Table 6. Cells highlighted in green indicate reduction in gross and net CDS exposure over the last year.

7 Responses to “CDS: Insurers Pay Only When the Bond Is ‘All Dead’”

RichMarch 12th, 2012 at 1:35 pm

Your distinction between "mostly dead" and "all dead" is correct. But that is the key distinction for CDS contracts. A borrower has either defaulted or it hasn't. Ie the market can be certain that a default will occur — the borrower is "mostly dead" — but the default itself has yet to occur. Greece did not default until it enforced the bond swap on unwilling holders via CACs. At that point, ISDA ruled it was a default. In the meantime, the price of Greek CDS kept on rising — acting as a hedge, since a holder of CDS could sell at any time to monetize that rise in price. And now holders will get paid out via the settlement process — so it's still a hedge.

If we had derivative contracts that triggered when a borrower was "mostly dead" it's quite possible the only winners would be the lawyers, who would have a field day arguing back and forth quite how "dead" the borrower was and whether it fitted the definition of "mostly". How much is "mostly" – 50% probability of default? 75%? 90%?

Rebecca WilderMarch 12th, 2012 at 1:49 pm

Hi Rich,

Yes, Greek CDS was still a hedge, even after the initial announcement of PSI. And yes, PSI is 'mostly dead' and perhaps when done in small size should not constitute default. But with the ECB getting special treatment and the forceable nature of the large NPV PSI, politically and otherwise, I'd argue that there's too fine a gray line between 'mostly dead' and 'all dead' that went unaddressed in the trigger. Had they gotten 95% PSI on the local bonds, then CDS probably wouldn't have been triggered. If I were short CDS, I'd be pretty upset about that.


Peter TchirMarch 12th, 2012 at 4:54 pm

Article is wrong in many ways.

1) Credit Events are very derailed and explicit and the committee followed the documents – as they have to.

2). Change in gross notionals are a function of a) shorts having made enough and unwinding, b) as price increased and counterparts risk increased, more effort was made to unwind/redundant trades, c) curve trades less interesting once they invert so curve trades unwind

3) if you were short CDS….have you ever been long or short CDS? Have you ever managed a single CDS trade?

Did you read the ISDA document to form any of the opinions

Rebecca WilderMarch 12th, 2012 at 5:51 pm


Yes, I read the Determination Committee's release. However, the Irish, Portuguese, and Greek CDS curves were inverted a year ago. And if there is a structural reduction in gross notional by unwinding redundant trades, wouldn't I expect to see a broader decline in gross exposure across the high beta markets, like in Hungary? I concede that you are the CDS trader/expert (read your blog).

Thanks, Rebecca

Ulysses S. RantMarch 12th, 2012 at 8:03 pm

Is the article really all that wrong? I'm not as fluent in this financial language as the rest of you seem to be, but it seems to me that the use of CDS for hedging or for "betting" is diminished when one party can retroactively change contracts to shift definitions and alter outcomes. How is this a good thing? How does this not undermine the integrity of the derivatives market?

David T. NowakowskiMarch 13th, 2012 at 2:10 pm

Even when there was some uncertainty about whether or not there would be a CDS event, how can anyone argue that the CDS in the Greek case did not function as a good hedge.

If one bought, say 2-year protection a year ago, at 1100 bps, even unwinding it at "only" 11,000bps before a default was a done deal would have been fine. And given the uncertainty at that point that holdouts might be paid, that the exchange might be delayed again (bondholders got paid 100 as late as December), or that the March bondholders might cut a better deal for higher recovery, I would say that CDS worked very well indeed.

Moreover, there have been many corporate bond exchanges or distressed buybacks that don't trigger CDS. Unfair? Hardly — tough luck, read the fine print.

The single-name CDS market is now $15.7 trillion, growing from $15.2 trillion a year ago according to DTCC. No sign of shattered confidence whatsoever.

THE CDS MARKET IS NOT FOR CHILDREN. It is for grown-up professionals, who know the risks (basis, liquidity, counterparty, recovery-auction, DC rulings, etc etc). It is not perfect, and it has and will continue to evolve, but especially after Greece, I would say it has proven its value to policymakers and market participants alike.

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