Two charts put out yesterday by Markit’s credit analyst Lisa Pollack suggest that contagion risk may be moving to European countries previously considered safe.
The first chart shows the net notional exposure to credit default swaps (CDS), referencing the three countries currently priced by the CDS market as most likely to default (Greece, Ireland, Portugal, in that order). The net notional value of CDS represents the sum of default protection purchased by buyers in the market, and is therefore a gauge of the level of investors’ interest in insuring against the risk of the relevant country defaulting on its debts.
The second chart measures net notional CDS volumes for the five largest European economies: Germany, France, the UK, Italy and Spain, over the same period.
Demand for credit protection against Greek default has actually fallen by over a third during the last year, points out Pollack, while for Portugal and Ireland the volume of insurance written via CDS has also fallen substantially.
The first chart is prima facie evidence that Greece’s slow drift towards default is not being provoked, as some European politicians have suggested, by speculators buying huge volumes of CDS to push credit spreads wider. The absolute level of CDS protection purchased on Greece—around US$5.5 billion—is also small when compared with the country’s total debt (€310 billion, according to the BIS).
There are also some technical factors behind the fall in demand for CDS on Europe’s riskier countries. For example, Portugal took the lead last summer in agreeing to post collateral with its market counterparties (historical market practice has been for postings of the collateral underlying derivatives contracts between banks and sovereigns to be one-way only, meaning that governments have historically insisted on some form of security from bank counterparties to back the latters’ promises, but have typically not felt obliged to offer the same surety in return). With this particular government now offering collateral to dealers, says Pollack, demand from the market to buy default protection has fallen.