Sovereign CDS and credit event
A derivative contract that pays the buyer if a country suffers a credit event, as determined by an ISDA committee, with the amount set by an auction on the defaulted bonds.
A credit default swap looks like insurance without being insurance: the buyer pays a periodic premium and is compensated if the reference entity defaults, but it does not need to hold the debt or suffer a loss. For a sovereign, credit events are mainly failure to pay, repudiation and restructuring that binds holders. The buyer does not declare the event; a determinations committee convened under ISDA does, which keeps a so-called voluntary restructuring from escaping the contract through labeling alone. The amount paid depends on an auction that sets the recovery rate on deliverable bonds. For a political risk insurer, the CDS spread is a market signal on default probability, not a measure of the loss on any given policy.
On March 9, 2012, the ISDA determinations committee ruled that a credit event had occurred on Greece after its collective action clauses were activated. The March 19 auction set recovery at 21.5 percent: protection sellers paid 78.5 percent of notional, about 3.2 billion dollars net. Since November 1, 2012, the EU short selling regulation has prohibited buying sovereign CDS without an underlying exposure.
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