Tuesday, 16 December 2008

Latam CDS Market Faces First Real Test With Ecuadorean Default (Update)

Ecuador President Rafael Correa said yesterday that his government won't honour any forthcoming debt payments. The country is now in arrears and, as a consequence of that, it was given a selective sovereign default rating immediately by S&P and Fitch. Argentina and Venezuela bonds took the toll of Correa's decision (Venezuelan bonds dropped almost 1.5 percentage point during yesterday's session, according to Bloomberg.)

But the most interesting development of this tale will be the reaction by investors in the sovereign CDS (credit-default swaps) markets. This is the first sovereign default in the region since Argentina's in 2001, and with CDS markets in Latin America fully in motion and fashion.   The triggering of default clauses on Ecuadorean CDS contracts will tell investors what to do if another case of moratorium follows Ecuador's.  I have no information about the size of outstanding contracts and physical bonds, but the issue of default shouldn't be terribly worrisome given Ecuador's total debt size (a relatively small $10-$11 billion) 

One reader was wondering how the settlements would be done among underwriters and holders of Ecuadorean CDS. According to a report by IDEAGlobal that was distributed today, the counterparty risk associated with such default terms is minor because, as what we said above, the size of Ecuador's overall debt is rather small. IDEAGlobal continues: ``A cash settlement auction similar to those famously executed within the confines of the U.S. marketplace for defaulted financial institutions will perform as a bellwether to verify the orderliness of obtaining a clearing price for this debt instrument, as well as clarifying if in fact the market balance was as even as publicised.'' 

The question is, the market for CDS remains quite obscure in Latin America and it is necessary to begin working on a regulatory framework (or self-regulatory framework maybe?) to act orderly in a situation like this. Finally, the closure of Ecuador CDS transactions may lead to an increase in offered prices for Ecuadorean debt instruments in coming days, so stay attentive to new developments.
 

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