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UPDATE 2-Argentina defaults but investors see deal possible eventually

(Adds ISDA, Argentina government, Credit Suisse comment)

BUENOS AIRES, July 31 (Reuters) - Argentina defaulted for the second time in 12 years after last-ditch talks with what it called "vulture" creditors failed, as focus turned to whether big banks and funds would request the declaration of a "credit event".

After a long legal battle with hedge funds which had rejected Argentina's debt restructuring following a 2002 default, Latin America's third-biggest economy failed to strike a deal in time to meet a midnight U.S. eastern time (0400 GMT) payment deadline.

Argentine Cabinet chief Jorge Capitanich hit out at U.S.-court appointed mediator Daniel Pollack, calling him "incompetent". Capitanich urged holders of Argentina's exchanged bonds to demand their money from the U.S. judge who blocked a June 30 payment, triggering the path to default.

The International Swaps and Derivatives Association (ISDA) said on Thursday it had received its first request to consider whether a credit event had occurred, according to the ISDA website.

Swiss bank UBS asked ISDA's determinations committee to consider whether a "failure to pay" credit event had occurred, citing a missed deadline to deliver interest payments to exchange bondholders.

If the request is accepted, the 15-member committee will vote on whether a payment on Argentine CDS contracts can be triggered. It could meet and make a decision as soon as Friday, market participants say, although the process could take longer.

Any ruling that a credit event had occurred would set off a series of insurance payments and give most of Argentina's current bondholders the right to demand their money back immediately. The deadline is Aug. 4, according to analysts.

Credit Suisse earlier said CDS were "likely to be triggered".

Emiliano Surballe, fixed income analyst at Bank Julius Baer said: "It is still not clear whether the credit default swap of the country will be triggered. The situation that generated the default was a lawsuit, not the failure of the country to transfer the proceeds to pay existing debt."

Argentina parked with its bankers the money to pay its current bondholders, but a U.S. legal ruling prevented it from doing so unless it paid off the holdout bondholders first.

"It's probably going to be more a soft default scenario where prices will slide a bit. There is confidence in what the government is going to do," said Rune Hejarskov, senior portfolio manager at Jyske Invest, which holds Argentinian debt.

The default could get much messier and take longer to clear up if creditors force an "acceleration" for early payment on their bonds. Some investors saw this as unlikely.

"I don't think at the moment there is a clear answer to whether bondholders will accelerate a deal. It's probably not something most bondholders would like to see," said Olivier De Timmerman, fixed income fund manager at KBC Asset Management in Luxembourg.

The bonds at the centre of the struggle had rallied strongly on Wednesday along with Buenos Aires stocks and the peso as bets on a deal rose, but traders were left up in the air after the talks fell apart.

"We expect part of (Wednesday's) rally to come back to couple of points ... Discount bond (bonds given to investors when Argentina restructured) prices will come back a bit and we will probably see a fair value around 85." said Hejarskov.

Even a short default will raise local companies' borrowing costs, pile more pressure on the peso, drain dwindling foreign reserves and fuel one of the world's highest inflation rates.

VERY PARTICULAR DEFAULT

Argentina had sought in vain a last-minute suspension of a ruling by U.S. District Judge Thomas Griesa in New York to pay holdouts $1.33 billion plus interest. He ruled Argentina could not service its exchange debt unless it paid the holdouts at the same time.

Cabinet chief Capitanich insisted Argentina was not in default as it had honored the June 30 coupon payment. Those funds are now stuck in limbo with Trustee agent Bank of New York Mellon.

"Argentina paid," Capitanich said. "As such, the bondholders should demand their money. (To say) that Argentina is in a technical default is an absurd hoax intended to destroy the whole restructuring process."

Bank of New York Mellon said in a statement bondholders "shall have the right to direct the time, method, and place of conducting any proceeding for any remedy available to the Trustee."

A proposal for Argentinian banks to buy out the hedge funds' non-performing debt also fell through, sources told Reuters.

Argentina's latest debt crisis is a far cry from the mayhem following the crash in 2001-2001 when the economy collapsed around a bankrupt government and millions of Argentines lost their jobs.

This time the government is solvent. How much pain the default inflicts on Argentina, which is already in recession, will depend on how swiftly the government can extricate itself from its obligations.

"This is a very particular default, there is no solvency problem, so everything depends on how quickly it is solved," said analyst Mauro Roca of Goldman Sachs.

Buenos Aires had argued that agreeing to the hedge funds' demands to pay them in full would break a clause barring it from offering better terms than those who accepted steep writedowns in the 2005 and 2010 swaps.

Capitanich said any deal between third parties and the holdouts would not violate the so-called RUFO clause.

The clause expires on Dec. 31, after which the government would also be able reach a deal with the funds. Many investors and economists hope for some solution after then.

"Our base case is that a default would be cleared by January 2015," said Alberto Bernal, a partner at Miami-based Bulltick Capital Markets. He projected that a default would cause the economy to shrink 2 percent this year compared with a previous market consensus for a 1 percent contraction.

Argentina's default is not seen unleashing financial turmoil abroad because it has been isolated from global credit markets since its 2002 default on $100 billion of debt.

It has foreign currency restructured debt worth about $35 billion, including $8 billion under local law, while its foreign exchange reserves stand at $29 billion.

U.S. ratings agency Standard & Poor's on Wednesday downgraded the country's long- and short-term foreign currency credit rating to "selective default".

Germany, which is Argentina's biggest individual creditor, expects Argentina "to continue to respect its commitments to the Paris club" of sovereign lenders, a spokesman for the German economy ministry said on Thursday.

He said an initial partial payment equivalent to $650 million had been transferred to creditor states on July 28/29 and that Germany expected the next instalment on existing arrears to be paid at the end of May 2015.

(Additional reporting by Richard Lough and Eliana Raszewski in Buenos Aires, Carolyn Cohn, Spriya Srivastava, Marc Jones and Andrew Winterbottom in London, Gernot Heller in Berlin, and Daniel Bases in New York; Editing by Jeremy Gaunt and James Dalgleish)