A small step forward, but the Greek restructuring deal could prove to be a pyrrhic victory

Open Europe has responded to the agreement between the Greek government and its private creditors which laid out how much and under what format the country’s massive €360bn debt burden should be written down. The deal involved private sector bondholders agreeing to a 53.5% nominal write-down, while so-called Collective Action Clauses (CACs) will be used meaning that Greece is now technically in a state of default – precisely what EU leaders have spent two years trying to avoid. While marking a small step forward, Open Europe notes that the deal is unlikely to save Greece, and that the country is still on course for a full default in three years’ time, if not sooner.

In our response we note:

“With the use of CACs Greece has entered a coercive restructuring or default – something which Greece and the eurozone have spent two years trying to avoid. While the financial markets can handle the triggering of CDS that this will entail, at some point serious questions need to be asked over the amount of time and money which policymakers have wasted on what has ultimately amounted to a failed policy. Instead, Greece should have undergone a full restructuring combined with a series of pro-growth measures.”

“There will be plenty of optimism in the corridors of power around the eurozone today, some of it justified – Greece has avoided a chaotic and unpredictable meltdown. However, this deal could end up being a Pyrrhic victory: the debt relief for Greece is far too small which means that another default could be around the corner, while the austerity targets are wholly unrealistic and kill off growth prospects. Furthermore, Greece’s debt will end up being almost completely owned by eurozone taxpayers and by exempting official taxpayer-backed institutions from the write-down, the deal has created a distorted, two-tier bond market.”

See here for the full response.

Update 17:00: Based on our figures and projections, the Telegraph has produced a handy graphic showing the break-down of the restructuring, the details of the write-down and where the money from the second bailout will end up. View it here.

A credible Greek threat?

The Greek Public Debt Management Agency put out an interesting press release (PR) yesterday. We won’t go over all of it, since it’s been heavily covered in the press, but it did raise one interesting point:

“The Republic’s representative noted that Greece’s economic programme does not contemplate the availability of funds to make payments to private sector creditors that decline to participate in PSI.”

This is widely being seen as a warning to those who hold Greek bonds governed by foreign law and who therefore may be more inclined to hold out due to the extra protection offered under foreign law (they are also subject to higher CAC threshold, meaning CACs are harder to use). Greece essentially says that any bondholder who doesn’t take write downs will be defaulted on (except the ECB).

So, is this a credible threat?

Well, firstly we won’t find out until 11 April since that is the settlement date for foreign law bonds under the restructuring plan.

But more importantly it raises the question of whether Greece could be setting itself up for a second default, at least in technical terms. Let us explain:

Greece will certainly be judged to be in default by the rating agencies after CACs are triggered, but once the bond swap is completed and new bonds are issued it should come out of this rating fairly quickly. Yet, a month later it could again trigger CACs on foreign law bonds. Even worse, it could just leave these bonds and default on them through non-payment as and when payments are due (this could run long into the future). If this constituted another default it would have a negative impact on funding for Greek banks and the stability of the economy - so would be something to avoid.

Ultimately, it comes down to whether the new Greek bonds have ‘cross-default clauses’ in them – which means if Greece defaults on other bonds it will default on these too. From what we can see, the new bonds do not have general cross-default clauses (despite earlier versions of the plan including them), only ones which apply to the new group of bonds which exist after the restructuring.

This makes the threat to default on the remaining foreign law bonds much more credible. It would still be an extreme course of action, but one which looks increasingly attractive given the extra debt relief it could deliver (which Greece will need).

This is something which bondholders would do well to keep in mind if they are planning to try and get paid out in full.

Decoding the ECB bond swap

As Die Welt reported yesterday, it now looks as if the ECB will swap it’s circa €55bn (nominal) holdings of Greek debt into newly issued Greek bonds provided by the Greek state. Below we attempt to summarise what this actually means. It’s a bit techie – so bear with us.

There are basically three options for Greece: a debt write-down that creditors agree to voluntarily, coercive restructuring (where Athens uses contract-based provisions to not pay back its creditors) or disorderly default (all hell breaks loose). Today’s deal has reduced the risk of the latter while increasing the chance/risk of the first two. However, it still hasn’t answered the question whether the ECB will actually itself take losses – or participate in some form – in a Greek restructuring.

Why is the ECB swapping its current holdings of Greek bonds for new ones?

Under this arrangement, the new bonds will be distinguished from the old ones in some way (possibly through different serial numbers) allowing Greece to pass legislation which retroactively imposes collective action clauses (CACs) on the rest of Greek debt held outside of the ECB. (This is sort of like the government hiking the tax rate today and then trying to claim 10 years of back tax at this higher rate). While a number of bondholders could agree to take write downs voluntarily, the remaining ones could be forced to do under these CACs. But the ECB is now safe. This matters tremendously since, if Greece went for a coercive restructuring without any special protection for the ECB, the institution could be faced with major losses and huge dents to its credibility – since it continually denied that it was taking too much risk since it saw a Greek default as impossible. The Eurozone and Germany in particular is keen to avoid this (see here for a whole range of political reasons why).

Open Europe take: While we have sympathy with the ECB for trying to avoid losses, this is a rather strange move (and a result of their flawed policy approach we might add). The preferential treatment it now has on Greek debt, suggests that the ECB’s wider holdings of eurozone debt from its bond purchase programme (around €220bn) are senior to eurozone debt held elsewhere. This could create uncertainty in the bond markets of the southern eurozone states, as bonds held by private creditors are much more likely to be next in line for a write down. More importantly, it also opens the ECB up to legal challenges, since some bond contracts will have clauses protecting them against subordination (negative pledge clauses). Importantly this worrying precedence is reported to be the reason why Bundesbank President Jens Weidmann objected to the move, further highlighting the fundamental disagreements within the ECB itself.

Doesn’t this increase the prospect of a voluntary restructuring?

The swap seems to have gone down well with markets. The perception is that private creditors – those that still hold out – will be much more likely to now accept voluntary losses, which – finally – can bring a conclusion to what has seemed like endless talks between creditors and the Greek government.

Open Europe take: The risk of a disorderly default on the 20 March has radically decreased, which must be considered a good thing. The Greek threat of forcing a coercive default using CACs is now much more credible (it can be done with fewer legal complications) which should force private sector bondholders to pull their finger out since they could face far greater losses under a coercive restructuring. At the same time, Greece now actually has the tools to push through a coercive restructuring (via the CACs) and a larger write-down, meaning that this option is still very much a possibility. So perhaps the markets are getting ahead of themselves.

Does this provide any additional debt relief for Greece?

No. There has been some confusion over this point. Currently the swap is 1:1 meaning the ECB will not take any losses or provide any monetary benefit to Greece. The ECB does seem to have agreed to distribute its ‘profits’ (revenues from the interest payments) on the new holdings so that they can be used to aid Greece.

Open Europe take: As we have noted before, the official sector will take losses in Greece, now or in the future (better now). The ECB should not take direct losses but forgoing the difference between the purchase and nominal price of its holdings of Greek debt would be beneficial. On a side note this episode highlights the lack of transparency surrounding the ECB's actions in the eurozone crisis. Despite purchasing the bonds at a discount the ECB holds the bonds at nominal value on its balance sheet, therefore selling them at purchase price means the ECB would still book a loss on paper. This is not an argument against the ECB providing some debt relief to Greece in of itself (by selling the bonds at purchase price), but more that the ECB does not correctly display risk on its balance sheet and did not create enough safeguards against such an event when it first decided to purchase eurozone government debt.

Furthermore, the concept of redistributing ECB ‘profits’ is flawed. The ECB already pays out any profits it makes to eurozone member states. It is then up to them to use the money how they see fit – it is a political decision, meaning the ECB’s comments about profits being used to aid Greece in this sense are more or less irrelevant.

Is this the end of the discussion with the ECB and Greece then?

Not quite. Once the switch to the new bonds has occurred there could still be scope for the ECB to offload them and sacrifice the difference between the purchase price and nominal value of their Greek holdings. The voluntary restructuring will move ahead and if it does not provide enough debt relief the pressure on the ECB to provide some additional relief will increase again.

Open Europe take: As we note above, Greece will probably need help from the ECB at some point. The Greek negotiating position is now significantly weakened since the ECB has greater protection. The ball is firmly in the ECB’s court – not exactly desirable given the opacity and stubbornness which it has presented so far in the eurozone crisis.