In the event of default, how is a Sovereign CDS settled. I suppose my question relates specifically to the estimation of the recovery rate. For cash settlement purposes, how would you calculate the recovery rate on a sovereign bond. I was reading Ephraim Clark's article from Wilmott magazine, where he pointed out that Argentina;s default on its foreign debt was entirely due to its willingness to pay (or lack of) and infact, its foreign reserves far exceeded the payment it defaulted on. What claim does a holder of a sovereign bond have over a countries assets, if any? I presume if you take a corporate CDS where the underlying is in default, you look at where you could sell that corporates assets as a means of recovering some of your investment.

See the thread "Recovery rates for credit derivatives" in the Student forum for a general explanation on how recovery rates for CDS is managed. In general there is no difference between how to establish the recovery rate for a sovereign bond and a corporate bond in a CDS context. You basically look at market prices for defaulted bonds. See eg the case of Ecuador that defaulted due to a lack of willingness to pay on certain issues on their global bond programs in (possibly december) early January 2009. The question about recovery rates for sovereign bonds in general is more tricky and you quickly run into (interesting) international legal questions that relates to details in the wording of the bond indenture. In general the default process works like this: the sovereign would first stop to pay on the bonds and then offer to buy back the defaulted debt at a discount or sometimes offer new bonds with eg longer maturities and lower principal or coupon in exchange for the old bonds. In order to get investors to agree to the exchange (or the buy-back) the sovereign would say that you only get this one chance and we will not pay on the old bonds. Regarding your question as to what claims a holder of a sov bond has on a country's assets I would say it depends on under which law the bond was issued and if sovereign immunity was waived in the bond indenture. The claims that an investor can make on the sovereign's assets is known as attachment. If sovereign immunity is waived and the bond is issued under New York law (common for emerging markets global bonds along with English law) then investors who opposes the bond exchange can freeze certain assets that belong to the sovereign, both domestically and internationally. The exact rules for attachment are complicated... For obvious reasons it is usually hard to claim assets in the country that defaulted but international assets can be seized (you go through a court procedure). Some argentine pension assets were freezed in New York in december due to hold out investors (ie investors who still own defaulted bonds from the last Argentine default) who claimed that the money should go to them. In an extreme case the hedge fund Elliot Associates LLP bought defaulted debt from peru some 15 years after the country had defaulted and stopped coupon payments on new peru bonds with reference to the pari passu clause in the bond indenture. Basically the question is legally very complicated so the question really is it depends. If you want I can give you some links to papers that give good answers to your questions. Please let me know and I will try to help you out more. HTH

here are some links to good and accessible papers concerning the pari passu clause and sovereign debt instruments. Within these papers you can find alot of information and references about questions such as attachments. Bratton, William W. “Pari Passu and a distressed Sovereign’s Rational Choices.” Georgetown University Law Center WorkingPaper. February 15, 2004Buchheit, Lee C. and Pam, Jeremiah S. “The pari passu clause in sovereign debt instruments.” Working Paper, 2003.Wood, Philip R. “Pari Passu Clauses—What do they mean?” Butterworths Journal of International Banking and FinancialLaw. November 2003, p. 371-374.HTH

Yes it definitely seems to be one for the lawyers...The area of interest for me is in taking cases to ICSID (International Centre for Settlement of Investment Disputes - Part of the World Bank). This is an arbitration process which is used frequently by Corporates who have a dispute regarding an investment in a particular country with that country's Government. From reading a number of articles, there appears to be a bias in favour of the Corporates. The issue for a bond holder is that there is vagueness as to the classification of Sov. bonds. For ICSID to look at a case, the dispute must be wrt to an invesment and Sov Bonds don't seem to be deemed investments. I suppose Lawyers need vagueness to justify their fees!! Il try get some links on particular ICSID cases if your interested. If i remember correctly, cases taken to ICSID by investors who wouldn't participate in the buy back.Thanks for the help - appreciate the links.

To my knowledge ICSID does not deal with sovereign defaults. Normally a sovereign default is worked out in the Paris club (for sovereign creditors) and in the London club (for non-sovereign creditors). Watch out for the Ecuador case. The bond holders of the defaulted Global 2012s has finally managed to vote in favor of an acceleration which is the first step in order to start a legal process. However, given the apparent coordination problems between the bond holders (Ecuador defaulted in mid november and only now have the bond holders agreed to accelerate (I think the trustee played an important role in the coordination so far but it will not involve itself after the acceleration)) legal action might prove to be a difficult task although there may be meritorious claims.