Sovereign Risk Management - Default Risk, Debt Restructuring and Investment Impacts

Duration:
2 days
Location:
Prague, NH Hotel Prague
  • Sovereign Debt Restructurings and Credit Events
  • Argentina, Greece and other Historical Sovereign Default Episodes
  • Assessing Sovereign Default Risk
  • Estimating Losses from Debt Restructurings
  • Legal Aspects of Sovereign Debt Restructurings
  • Using Credit Derivatives to Hedge against Sovereign Risks
  • Hedging Debasement Risk
  • Sovereign Bond Portfolio Management
The purpose of this course is to give you a good understanding of sovereign risk and of the tools and techniques for assessing and managing sovereign risk in an investment context.

We start with a general introduction to sovereign risk. We introduce and explain basic concepts such as "restructurings", "credit events", "haircuts" and "debt relief", and we give an overview of historical sovereign debt restructuring episodes including Argentina and Greece and we discuss how they have affected investors and the broader economy. We also explain how governments have historically used "debasing" and "financial repression" as strategies for reducing real debt levels, and we discuss the possible consequences of such strategies for investors.

We then give you a thorough explanation of methods for assessing the risk that a sovereign might default on its debt obligations. We identify fundamental drivers of sovereign credit quality. We explain how to assess the "fiscal space", i.e. whether the fiscal dynamics of a particular country are on a sustainable path and how close a country is to breaking through a level of debt that will cause it to default. We explain how a country's external finance position measures how exposed a country might be to macroeconomic trade and policy shocks outside of its control. We explain the degree to which the financial sector of a country poses a threat to its creditworthiness, and we discuss factors that suggest both ability and willingness to pay off real debts. We explain and demonstrate how some of these fundamental drivers of credit quality can be used in conjunction with quantitative models such as the "Merton" model to estimate the likelihood of a sovereign default. We also explain how rating agencies use this type of information in the rating process.

Further, we look into how credit losses (and recoveries) in sovereign restructurings can be assessed. We explain different approaches to calculating the "haircuts", illustrated by historical examples. We also explain how losses can be reduced through the process of sovereign debt restructuring. We explain key elements in a debt restructuring process, the role of the "Paris Club" in restructuring bilateral debt, how bank loans are restructured under the "London Club" arrangements and how sovereign bond exchanges are negotiated and implemented. We also explain important legal aspects of sovereign debt restructurings including the so-called "collective action clauses" and possible creditor litigation actions, and we give an overview of pitfalls in the restructuring process.

Finally, we look at methods and tools for pricing, mitigating and/or transferring sovereign risk in a portfolio management context. We explain and demonstrate how credit derivatives can be used to hedge against outright sovereign defaults and against mark-to-market losses following changes in implied default probabilities (spread changes). Examples will include the use of SovX contracts to hedge a portfolio of sovereign risk. We also explain and demonstrate how diversification can be used to reduce portfolio risk and how inflation-linked products can be used to hedge against "debasement risk".

09.15 - 12.00 Sovereign Risk – Fundamental Concepts and Historical Episodes

  • Restructurings, Credit Events, “Haircuts” and Debt Relief
  • Debasement and Financial Repression
  • A Brief History of Sovereign Defaults and their Consequences for Investors
    • When and How Often Was Sovereign Debt Restructured?
    • Characteristics of Bond and Bank Debt Restructurings Since 1998
    • Case Studies: Argentina, Greece,…
    • Financial and Macroeconomic Conditions During Restructuring Episodes
    • Evolution of Credit Ratings During Restructuring Episodes

Assessing Sovereign Default Risk

  • Fundamental Drivers of Sovereign Credit Quality
  • Assessing the “Fiscal Space”
    • Debt/GDP and per Capita GDP
    • Proportion of Domestically-Held Debt and Term Structure of Debt
    • Demographic Profile
    • Growth and Inflation Volatility
    • Debt/Revenue
    • Depth of Funding Capacity
    • Default History
    • Reserve Currency Status
    • Interest Rate on Debt
  • Case Study and Exercise

12.00 - 13.00 Lunch

13.00 - 16.30 Assessing Sovereign Default Risk (Continued)

  • Assessing the External Finance Position
    • External Debt/GDP
    • Current Account Position
  • Assessing the Financial Sector Health
    • Bank Credit Quality and Size
    • Credit Bubble Risk
  • Assessing Willingness to Pay (Political/Institutional Factors)
  • An Index for Sovereign Risk
    • Weighing the Factors together into an Index for Sovereign Risk
    • The Correlation of the Index with Sovereign CDS Spreads
    • Practical Examples for Selected Countries
  • Quantitative Models for Assessing Sovereign Risk
    • Using the Merton Model to Estimate Default Risk
    • Calculating Implied (Risk-Neutral) Default Probabilities from CDS-Spreads
  • External Sovereign Ratings and their Interpretations
    • Rating Criteria and Rating Methodologies
    • The Impact of Sovereign Credit Ratings on the Sovereign Bond Markets
  • Case Studies and Small Exercise

Day Two

09.00 - 09.15 Brief recap

09.15 - 12.00 Assessing Credit Losses/Recoveries in Sovereign Bond Restructurings

  • Debt Rescheduling vs. Debt Reduction
  • Debt Restructuring Vehicles by Type of Creditor
    • Restructuring Bilateral Debt: The Paris Club
    • Restructuring Bank Loans: The London Club
    • Sovereign Bond Exchanges
  • The Duration of Debt Renegotiations
  • Stylized Timeline of a Sovereign Debt Restructuring
    • Negotiations
    • Exchange Offer
    • Debt Exchange
  • Pitfalls in the Restructuring Process
  • Approaches to Calculating the “Haircut”
    • Comparing the Present Values of New Instruments with Face Value Amount of Old Debt
    • Comparing The Present Values of the New and Old Instruments
    • A Stylized Example - Total Debt Service Before and After Restructuring
  • Legal Aspects of Sovereign Debt Restructurings
    • Governing Laws
    • Collective Action Clauses
    • Creditor Litigation Against Debtor Governments
    • Case Study: Elliot Associates vs. Argentina
  • Practical Examples and Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Managing Sovereign Risk in an Investment Portfolio Context

  • Managing Portfolios of Sovereign Bonds
    • Diversification
    • Portfolio Optimization under Sovereign Risk Constraints
    • Investing in Distressed Sovereign Bonds
  • Transferring Sovereign Risk with Credit Default Swaps
    • Mechanics of Sovereign CDS Contracts
    • The Settlement of Sovereign CDS Contracts
    • Examples of Hedging with Sovereign CDS
    • Potential Distortions: Insurable Interest and the “Empty Creditor” Problem
  • Hedging Spread Risk with Single-Name and Index CDS’s
  • Securitization of Sovereign Risk
  • Using Index-Linked Bonds and Swaps to Hedge against Debasement Risk
  • Strategies for Protecting against Financial Repression
  • Practical Examples and Small Exercises

Summary, Evaluation and Termination of the Seminar

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