The ECB has had a focus on stopping the CDS market from working. They have looked at Naked CDS bans. They have floated rumors about selling CDS. They worked hard to avoid triggering CDS on Greece.
The EU has always been against short selling. They like to ban short selling on stocks.
For whatever reason, they have left bond shorts alone for the most part. Is LTRO and its emphasis on sovereign debt, a way to control the borrow on these bonds? Is the ECB trying to control bonds so they can’t be borrowed?
If a bank holds the bonds, they may lend them to a hedge fund to short. Some trading revenue and reverse repo revenue for the bank.
Is LTRO a way to have the ECB in control of ever more bonds in an attempt to make it more difficult to short bonds? It would push shorts out the curve where they have to take more risk if somehow Europe fixes itself.
In the end the bond market is so big, this program is likely to be relatively small, and most shorts prefer to be out the curve in the first place, but another thing to be wary of when shorting.
Einhorn Trades Swaps for Shorts When Betting on Sovereign Debt
2011-12-16 05:00:01.6 GMT
By Miles Weiss
Dec. 16 (Bloomberg) — David Einhorn, the hedge-fund
manager who compared the Greek bailout to a surrealist painting,
recast a bet against sovereign debt in a way that reduces risks
posed by government regulators and big banks.
Greenlight Capital Re Ltd., a publicly traded insurer
controlled by Einhorn, held credit default swaps on $667 million
of sovereign debt as of June 30. During the third quarter, the
company exited about half of those swaps, designed to pay off
should a government default, and entered into short sales on
non-U.S. sovereign bonds, according to a regulatory filing.
By replacing the swaps with short sales, Einhorn maintained
his ability to profit from a sell-off in government bonds while
avoiding potential pitfalls that he identified in a July 7
investor letter. Greenlight wrote that regulators were seeking
to prevent a triggering of credit default swaps tied to
sovereign debt, in part because the payouts could devastate
European banks that had agreed to provide the insurance.
“There are at least three or four fairly large funds that
have done exactly the same thing as David Einhorn,” said Gary
Swiman, who heads the asset manager and brokerage division at
ICS Risk Advisors, a New York-based consulting firm. “You go
from a private market that is unregulated at this time to
publicly issued government sovereign debt that is transparent.”
The net amount of swaps written on France, Greece, Italy,
Portugal and Spain declined to $66.8 billion at Dec. 2 from
$74.5 billion at Jan. 7, according to data from the Depository
Trust & Clearing Corp., a New York-based central repository for
credit swaps. The largest reduction was for Greece, which had
$3.4 billion of net credit swaps on its sovereign debt at Dec.
2, down 46 percent from $6.3 billion at Jan. 7.
Einhorn, 43, the president of New York-based Greenlight
Capital Inc., invests in companies he deems undervalued and also
makes wagers against those he considers overpriced, ranging from
Lehman Brothers Holdings Inc. in 2008 to Green Mountain Coffee
Roasters Inc. earlier this year.
In addition to running hedge funds, an affiliate of his
firm helps invest the assets of Greenlight Re, a Cayman Islands
company that provides reinsurance to insurers by assuming some
of their policy risk in return for a share of premiums.
Greenlight Re’s holdings mirror those of Einhorn’s hedge funds,
according to a person familiar with the matter, who asked not to
be identified because the information isn’t public.
Greenlight Re reported in an Oct. 31 filing with the U.S.
Securities and Exchange Commission that it sold credit swaps on
sovereign debt with a face value of $294.6 million during the
third quarter. The firm also sold short $153.8 million worth of
non-U.S. sovereign debt, according to the filing.
Jonathan Gasthalter, a Greenlight spokesman, declined to
comment on the trades.
Greenlight Re may have switched from credit swaps to short
sales of sovereign debt for a variety of reasons. These include
the possibility of realizing profit as the price of insuring
European sovereign debt soared during the third quarter.
The annual cost for insuring $10 million of Italian
government bonds under a five-year contract, for example,
reached $534,370 on Sept. 22, up from $171,625 on June 30,
according to data compiled by Bloomberg. Greenlight Re
recognized $22.7 million of gains from its sovereign-credit
swaps during the third quarter after recording losses of about
$7.2 million during the first six months of last year, according
to its quarterly filings.
Interest Rate Bets
In addition, short positions provide more profit potential
than credit swaps should interest rates rise and cause
sovereign-bond prices to decline.
After adding the short positions, Greenlight Re said in
company filings that its “debt instruments” would have
increased in value by $11.5 million if interest rates had
increased by one percentage point on Sept. 30. As of June 30,
before the short positions were added, the comparable gain in
the company’s debt holdings from a one percent interest rate
increase would have been $82,100, the filings show.
In a short sale, an investor borrows and then sells a bond
in the open market, hoping to profit by repurchasing it at a
lower price after the security declines in value.
Credit swaps, similar to bond insurance, can be used to
protect investments or to speculate on a company’s
creditworthiness. An investor receives premiums from a second
investor in return for agreeing to make a cash payment to the
latter, equaling the face value of the bond covered by the
agreement minus any recovery value, should the issuer of the
debt suffer a setback such as bankruptcy or a ratings downgrade.
“A CDS trade is in many ways economically equivalent to
simply shorting a bond and borrowing it for the term of the
trade,” said Jonathan Cooper, a senior consultant at Finadium,
a Concord, Massachusetts, research and consulting firm that
specializes in financial markets.
Each type of trade has pros and cons, according to Cooper
and Swiman at ICS Risk Advisors. It’s hard to short a bond for
more than a few months, while credit swaps typically run five
years. On the other hand, credit swaps are private contracts and
require investors to rely on the creditworthiness of their
“The other side of the trade is someone basically selling
you insurance,” Swiman said. “But when you can’t tell how
solvent they are and how much other CDS they have sold to other
counterparties, it creates fear.”
Treachery of Images
Greenlight revealed some of its thinking in a July 7
investor letter that cites “The Treachery of Images,” a
painting by the Belgian surrealist Rene Magritte, in discussing
European efforts to avoid a Greek debt default.
The letter touched on two risks tied to credit swaps on
European sovereign debt, including regulators’ attempts to
fashion a Greek bailout in a way that prevented the contracts
from paying out. The second risk was the possibility that banks
that wrote billions of dollars in credit swaps on sovereign debt
might not be able to make good on their obligations should a
country such as Greece actually default.
Greenlight, citing French President Nicolas Sarkozy in
particular, noted that regulators were determined to prevent the
Greek bailout from being classified as a “credit event,” which
would trigger a payout to swap holders. Stating that “it is
very odd to hear a political leader use such technical jargon,”
Greenlight then asks in the letter “Why would Mr. Sarkozy do
The letter raises the possibility that French banks have
“enormous exposure” to sovereign-credit events. That’s because
banking regulations define sovereign credits as risk free,
allowing banks to take on as much sovereign-credit risk as they
wanted, perhaps by issuing credit swaps, without having to set
aside any capital.
“Under such a structure, selling short CDS protection is
akin to free money for the banks,” Greenlight says in the
letter. “No one knows just how much aggregate exposure to
sovereign debt and CDS is hidden in the banking system, and no
one is itching to find out.”
In late October, the European Union reached an agreement
where banks would write down their holdings of Greek bonds by 50
percent. The International Swaps and Derivatives Association’s
chief lawyer said because the deal is considered voluntary, it
won’t require firms that sold credit protection on Greece to pay
buyers of the swaps.
In describing the potential for this sort of outcome back
in July, Greenlight recalled that Magritte’s pipe painting
includes a caption that translates to “This is not a pipe.”
Magritte proved the image was not a pipe by telling doubters,
‘Just try to fill it with tobacco’.
“As Magritte might say, ‘This is not a default’,”
Greenlight wrote. “Just try to collect on your credit default
For Related News and Information:
SEC Filings: EDGS
Hedge Fund News: NI HEDGE <GO>
Credit Derivatives: CDS <GO>
–Editors: Steven Crabill, Christian Baumgaertel
To contact the reporter on this story:
Miles Weiss in Washington at +1-202-624-1899 or
To contact the editor responsible for this story:
Christian Baumgaertel at +1-617-210-4624 or