So the ISDA committee pontificated on the Greek bond-swap, the smoke issued from the chimney and yes, habemus papam, we have a Credit Event.
This is interesting. The conspiracy theorists had predicted the committee would be swayed by substantial Wall Street influences to vote the other way - against all reasonable judgement - in order to avoid them having to pay out (mainly to European banks) on untold billions of CDS liabilities. You could see why they might: and the word was that an avalanche of systemic risk would otherwise be realised.
Well, t'committee jumped the right way and good on 'em. The whole purpose of ISDA is to have an internationally credible contractual basis for transacting derivatives. ISDA provides definitive guidance on contract language for drawing up forwards, swaps, options etc to ensure the transactions (a) achieve the desired commercial result and (b) are enforceable, which isn't always easy. The problems relating to the first part of this have largely been long-since solved; and for enforceability the usual solution is to have the contracts made subject to English or New York law (i.e. common law, none of your civil code nonsense). But bankruptcy and default will often perforce be subject to overriding local law, and in consequence most of ISDA's work over the past decade or more has related to 'credit support' issues. ISDA's credibility is absolutely vital.
Here's the puzzle. Far from this excellent decision resulting in meltdown,
"according to the Depository Trust & Clearing Corporation’s CDS data warehouse, the total net exposure of market participants who have sold CDS credit protection on Greek sovereign debt is approximately $3.2bn as of March 2, 2012"
and the payout would of course be even less - i.e peanuts, relatively speaking. Do we believe this ? Time will tell.
Incidentally, when writing that ISDA's cred is vital I am conscious that some C@W readers consider derivatives to be the work of Old Nick. Well, take it from Young(er) Nick, this is badly misconceived. Example: without liquid forward markets in commodities there can be no effective & sustainable competitive markets in the physical commodities themselves, for reasons I could bore you with at length. Does anyone around here doubt we need competitive conditions in such markets ? I hope not.
And for effective forward markets, as with any derivatives, we need (inter alia) bankable contracts, and depth - which in turn requires speculative money at the table and plenty of it, as well as 'natural counterparts'. We must hope that things are as benign as they now seem, and that the hype around ISDA's Greek decision was as ill-informed as the Y2K nonsense.