Isda prepares to settle Ecuador CDS

The International Swaps and Derivatives Association (Isda) is drawing up a settlement protocol for credit default swaps (CDS) based on the sovereign debt of Ecuador, which refused to make a $30.6 million scheduled interest payment last week.

The settlement protocol will be Isda's first on a sovereign underlying. Ecuador last defaulted on its debt in 1999, before the development of a liquid CDS market.

The payment was originally due a month ago, but Ecuador announced on November 14 that it would delay paying by 30 days while it investigated the legality of the $1.25 billion worth of 2012 bonds. Ecuadorean president Rafael Correa said on December 12 that the debt was "immoral and illegitimate" and that he was prepared to face creditors in court.

The 2012 bonds are now trading at 20 cents on the dollar - they dropped from 41.175 to 26.5 when the first payment delay was announced. Ecuador's credit rating was cut to CCC- from B- by Standard & Poor's last month - the agency cut its rating to "selective default" after last week's announcement. On December 15, finance minister Elsa Viteri said the country would also default on its 2015 bonds.

Even before taking office in January last year, Correa had suggested a default was possible, saying much of the country's foreign debt was illegitimate. In February 2007 the finance ministry warned it would delay a scheduled payment of $135 million on its 2030 bonds, before reversing itself and making the payment on time two days later.

CDS writers face heavy losses as a result of the default, as recovery rates are expected to be low, said Alessandra Alecci, a senior analyst in Moody's sovereign risk group in New York. "We expect negotiations with bondholders to be complicated and drawn out, with bondholder participation in an exchange perhaps limited by the country's solvency and its unclear grounds for default," Alecci said, predicting long negotiations with the country's government over recovery. Unlike the 1999 default, she added, there was no strong economic or fiscal case for the default - Ecuador is an oil exporter with a relatively strong economy and low debt levels.

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