In my last article, "Europe: Playing Musical Chairs With Credit Default Swaps," I referenced the conflicting accounts of total exposure. Considering that the CDS market is not something that I deal with, I set out to uncover information on the subject. Needless to say, I can see why even experienced financial reporters have a difficult time understanding this market.
But first we must look at the definitions, because the headings found in the tables provided by the Depository Trust & Clearing Corporation (DTCC) are not easily digested, and "Net Notional" is extremely important as defined (pdf) by the DTCC.
Net notional positions generally represent the maximum possible net funds transfers between net sellers of protection and net buyers of protection that could be required upon the occurrence of a credit event relating to particular reference entities. (Actual net funds transfers are dependent on the recovery rate for the underlying bonds or other debt instruments.)
The first word to catch my eye was "generally," which implies that exceptions to the rule exist, but the reference to "dependent on recovery rate" is far more important. The table in question lists the top 1,000 entries (takes a while to load) and the data was last updated on January 13, 2012. I include the top 18 rows.
Click to enlarge
Take Greece for example, shown as the Hellenic Republic, and the "Gross Notional" value is about $70 billion, with the "Net Notional" in the neighborhood of $3.2 billion. By contrast, Italy is the top entry with $308 billion gross and $21 billion net.
If I'm reading the definitions correct, the DTCC's data show a recovery rate of 95.5% for Greece (net notional/gross notional) and a 93% recovery rate for Italy. In short, if one bought $1 worth of Greek bonds and the country defaulted, the seller of the CDS would pay $1 to the bond holder, or CDS buyer, and take a loss of 4.5 cents. In Italy's case the loss would be 7 cents on the dollar. Considering the miniscule amounts, I fail to see what is holding up the Greek debt negotiations.
Yet, and as reported by Reuters, "a law on so-called collective action clauses forcing holdouts to accept losses could be drafted if Greece deems the participation rate unsatisfactory, Greek officials said," highlighting the fact that a "credit event" is to be avoided at any cost.
Maybe my poor math skills cannot consolidate the DTCC data with a Greek 50% haircut, and most likely a transfer of funds will take place behind close doors. And maybe, just maybe, that is why the IMF is begging for another $600 billion.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.