The Price of Restructuring: CDS Market vs. BIS

Relating to my discussion yesterday of whether the BIS should reduce the penalty for excluding the "modified restructuring" (Mod-R) credit event from CDS contracts, which is currently a 40% reduction in capital relief, a friend at a dealer bank has informed me that the spread between contracts with Mod-R and contracts with no restructuring credit event (known as "No-R") is roughly 9 basis points.

In other words, the market value of CDS contracts with restructuring is only slightly higher than the market value of CDS contracts without restructuring as a credit event. The BIS, however, contends that contracts with restructuring are worth 40% more than contracts without restructuring. While CDS market pricing isn't perfect by any means, it still suggests that the penalty for excluding Mod-R should be significantly less than a 40% reduction in capital relief. The BIS was receptive to this argument after the Conseco/Argentina fiascos spawned Mod-R and Mod-Mod-R (the European version), even though it didn't ever actually reduce the capital charge for excluding restructuring, so it'll be interesting to see what the BIS ends up doing.

[Edited to fix a minor math error, which had no effect on the overall argument. Note to self: don't do math while wasting time in an airport lounge area.]