In a CEPR discussion paper Christian Bayer, Chi Kim, Alexander Kriwoluzky analyze redenomination risk during the European debt crisis and how the European Central Bank’s interventions affected this risk. They conclude that the risk fell in the case of Italy but increased for France and Germany.
From the abstract:
… first estimate daily default-risk-free yield curves for French, German, and Italian bonds that can be redenominated and for bonds that cannot. Then, we extract the compensation for redenomination risk from the yield spreads between these two types of bonds. Redenomination risk primarily shows up at the short end of yield curves. At the height of the euro crisis, spreads between first-year yields were close to 7% for Italy and up to -2% for Germany. The ECB’s interventions designed to reduce breakup risk successfully did so for Italy, but increased it for France and Germany.
See also this earlier blogpost.
In the FT (Alphaville), Marcello Minnena explains what type of currency denominations of Euro area sovereign debt constitute credit events; and how markets assess the risk of such denominations.
After the Greek default in 2012
new ISDA standards entered into force: contracts made since 2014 protect against euro area countries redenominating their debt into new national currencies [unless the debt is redenominated] into a reserve currency: the US dollar, the Canadian dollar, the British pound, the Japanese yen, or the Swiss franc. In all other cases, the only way to avoid the triggering of a credit event is if the switch to the new currency does not result in a loss for the investor: “no reduction in the rate or amount of interest, principal or premium payable”.
Since 2014 two types of sovereign CDS therefore coexist: the old (ISDA 2003) and the new (ISDA 2014). The latter has always traded at spreads wider than the CDS-2003, but the difference (the ISDA basis) has generally been small: 15-20 bps for Italy, 8-12 bps for Spain, 2-4 bps for France, and 1-2 bps for Germany.
Since January 2017, the spread difference for Italy and France has increased by roughly 20 basis points.
On the FT Alphaville blog, Mark Weidemaier and Mitu Gulati argue that re-denomination risk in the Euro zone is most prominent in France and Italy. Bonds with CACs trade at higher prices.
Most French and Italian [but not Greek] debt is governed by local law. … the governments could pass legislation redenominating their bonds from euros to francs or lira.
… [But] some French and Italian bonds — bonds issued after January 1, 2013, with maturities over a year — have Collective Action Clauses (CACs). … Importantly, these CACs require a super-majority of investors (in principal amount) to approve any changes to the currency of the bond.
… But it’s also possible a local law bond is no different than a local law bond with a CAC. After all, both are ultimately subject to the whims of the local legislature, and the courts may side with them.
The markets seem to have a view, though: CAC bonds in the countries with heightened redenomination risk seem to be valued significantly more.
Websites with information about the “Lex Monetae” principle: