Sovereign default and re-denomination risk remain

European structured finance trading and issuance trends have been impacted by wider concerns stemming from the European sovereign debt crisis - particularly towards the end of 2011, when spreads moved steadily wider and issuers shied away from the primary market. While the market appears to have started 2012 with renewed confidence, several unfavourable scenarios remain possible, such as a sovereign default and currency redenomination within the eurozone.

In the following article - written for SCI's upcoming Pricing & Valuation Guide 2012 - Interactive Data's director of EMEA valuations, Anthony Belcher, examines the impact of the sovereign crisis on the pricing and valuation of structured finance bonds, the practicalities of pricing securities in the event of a sovereign default or currency re-denomination and the benefits of an evaluated pricing approach in times of economic uncertainty. The full chapter can be downloaded here.

According to Belcher, an actual split of the eurozone and the re-denomination of collateral and contracts would be an event of much larger magnitude than a sovereign default. "While current market opinion does not gauge re-denomination as a significant probability, the market believes there is a far greater chance of it happening now than there was a year ago," he says. "In a re-denomination scenario, the challenge for our evaluated pricing systems would come in the form of understanding which securities and which agreements would move to different currencies."

For example, if debt is denominated in euros, would it remain in euros or move to a new currency? This, says Belcher, is where the main source of valuation uncertainty lies: determining if the impact of currency re-denomination on the pricing of specific securities will be correlated with what happens to the denomination of the outstanding debt.

"It is critical in times of economic crisis, such as in the aftermath of the Lehman bankruptcy, to keep lines of communication with clients open to help cope with stress in the marketplace," adds Belcher. "Significant lessons have been learnt from the aftermath of Lehman's default. One of the most significant issues is understanding the current situation by talking to market participants and feeding that data into relevant systems. Interactive Data has prepared for this by increasing the number of our sources and contacts within the market."

Pricing, evaluations and reference data are provided in the US through Interactive Data Pricing and Reference Data, Inc. and internationally through Interactive Data (Europe) Ltd. and Interactive Data (Australia) Pty Ltd.

Limitations
This document is provided for informational purposes only. The information contained in this document is subject to change without notice and does not constitute any form of warranty, representation, or undertaking. Nothing herein should in any way be deemed to alter the legal rights and obligations contained in agreements between Interactive Data (Europe) Ltd and its clients relating to any products or services described herein. Nothing herein is intended to constitute legal, tax or other professional advice. Interactive Data (Europe) Ltd makes no warranties whatsoever, either express or implied, as to merchantability, fitness for a particular purpose, or any other matter. Without limiting the foregoing, Interactive Data (Europe) Ltd makes no representation or warranty that any data or information (including, but not limited to, evaluations) supplied to or by it are complete or free from errors, omissions, or defects.