I’ve gotta tell you, the French election risk story just gets better and better. Or, depending on how one looks at it, worse and worse.
I’ve already documented the rather disconcerting fact that thanks in part to post-crisis deleveraging in Germany, French IG credit now comprises something like a quarter of the € IG market. Put simply: hedging a potential redenomination event entails trying to figure out how to protect against a catastrophe in €410 billion worth of French corporate bonds. Obviously, that’s impossible. You can’t hedge that risk.
And that’s just the corporate side of things.
On the public debt side, Marine Le Pen’s pledge to take France out of the EMU (or, as she euphemistically puts it, “taking back the country’s monetary sovereignty”) would likely end up triggering the largest sovereign default in the history of the world. And no, that’s not hyperbole.
You can review some previous posts on this here:
- “They’re Stealing Our Jobs!”: Populism And False Prophets
- You Are Being Politically Exploited
- 1.7 Trillion Reasons Why This Whole Populist Thing Is A Bad Idea
- “This Time, The Experts Aren’t Exaggerating”: A Former Goldmanite’s Warning To Markets
Of course the “establishment” has tried to warn French voters about this. As ECB executive board member Benoît Cœuré’s not-so-delicately put it earlier this month:
[Le Pen’s redenomination push] would lead to impoverishment that would threaten the jobs and savings of the French people.
Doesn’t get much clearer than that.
But that’s the beauty of populist rhetoric. These politicians feed off of just those type of warnings. “It’s the elites and the bureaucrats trying to preserve a system that only benefits them,” the likes of Trump and Le Pen will tell you.
No, it’s reasonable people trying to tell you that a €1.7 trillion sovereign default would be a colossal clusterf*ck the likes of which the market has never seen, that’s what it is. So remember I said that.
In any event, I thought, given the extensive discussion in these pages about why Marine Le Pen and her pledge to restore France’s “monetary sovereignty” is so dangerous (not to mention bats*t crazy), readers might enjoy the following excerpts from a new Citi note in which the bank’s analysts explain that not all credit default swaps are created equal.
What protection are you paying for? Marine Le Pen’s proposal to take France out of the euro is once again raising questions about whether CDS will “do what it says on the tin”. As on previous occasions, we fear the answer is “not necessarily”.
In the event of redenomination, we see much more value in French 2014 sovereign CDS contracts than on the 2003 docs. By our interpretation, redenomination might well, but wouldn’t necessarily, constitute restructuring on the 2014 contracts, depending on the interpretation of what constitutes a haircut. However, a restructuring credit event upon redenomination is unlikely for the 2003 contracts, as francs would constitute a permissible G7 successor currency. Additionally, whilst not our base case, a ‘Failure to Pay’ is also more likely for the 2014 contracts than for the 2003s. Whether or not failure to pay is deemed to have occurred will depend on whether the principle of lex monetae is applied by the DC, i.e. whether franc bonds are thought of under French or European law. The 2014 documents contain clear stipulations potentially allowing for Failure to Pay to trigger, but the 2003 contracts don’t, making them less likely to compensate investors.
These concerns have decompressed the ‘ISDA Basis’, i.e. 2014s have widened more than 2003s, but we think this has further to go. We would expect the 2014s to continue to move in line with perceived French political risks – likely widening in the run-up to, and immediately following, the first election round, but probably tightening thereafter (a victory for the Front National is not our base case). But for the 2003s, we would question the value of protection – especially relative to the 2014s, but even in outright terms. The 10bp spread difference between the two does not come close to reflecting the difference in value, in our view.
So you know, if you’re looking for some carry, selling protection on those worthless piece of sh*t 2003s might be one way to go.
Or, summed up for all the credit junkies out there…