Why Might a CDS Contract Not Cover Certain Types of Government Intervention or Bailouts?

A CDS contract may not be triggered by government intervention if the action does not meet the specific, legalistic definition of a credit event outlined in the ISDA Master Agreement. For example, a government providing a loan or capital injection to a struggling bank (a bailout) is not a "failure to pay" or "bankruptcy." If the intervention prevents the company from defaulting on its existing debt obligations, then no credit event has occurred.

This can lead to situations where bondholders suffer losses in substance, but CDS holders receive no payout, a discrepancy known as a "basis risk."