Last Updated Nov 27, 2009 7:23 AM EST
Thursday, state-run port operator Dubai World said that it was requesting from its creditors a six-month halt on its debt repayments until May. As a result, credit default swaps on Dubai's sovereign debt soared 134 basis points to 675. The swaps have increased 122 percent in value in the past week.
Credit default swaps are derivatives which are used by institutional investors as insurance contracts in the event an entity's default. As the likelihood of bankruptcy or the inability to meet a debt repayment rises, so in turn do the value of CDS contracts.
Some of the speculation may be overblown, according to analysts at BNP Paribas. The analysts noted earlier this week that a default by Dubai World would not trigger CDS contracts linked to the state of Dubai, since the government does not guarantee the debt of the firm.
A London-based investment banker I spoke with yesterday was floating a different theory: "The news on Dubai potential debt default is interesting but apparently won't happen, plus there is a view that this is an Abu Dhabi squeeze play so it can exert more control." Indeed, Abu Dhabi Commercial Bank has at least between $2.2 billion to $2.5 billion of exposure to Dubai World, and the current halt on debt repayments will force the bank to make more bad loan provisions.
Dubai had already raised $5 billion in debt from Abu Dhabi banks earlier this year. Paul Amery of IndexUniverse.com argues that the events may signal the beginning of a financial crisis among sovereign debt issuers:
To add insult to injury for affected creditors, the Dubai government had earlier raised US$5 billion in loans from banks in Abu Dhabi, which most had assumed was to be used to retire the Dubai World bond due in December. Strange behaviour for those third party observers expecting repayment, but perhaps not by an issuer expecting to be shut out of the capital markets after defaulting..."We have to face the stress that will be caused to our balance sheet and profit and loss account due to this exposure to Dubai World and associated companies because it is a default," one Abu Dhabi Commercial Bank executive, who declined to be named, told newswire Reuters.