11 January 2012

FT: Greece's private sector deal unlikely to be final act

Not for the first time, a PSI deal in Greece is imminent. Bondholders are braced for a net present value loss of about 60 per cent, although finer details are still being debated, and in the worst case could be held up again.

Few people come out of the PSI debate looking good. Germany and France pushed ahead with it despite warnings from the European Central Bank about the contagion it would, and did, unleash. At certain stages, banks have looked to be getting away with it lightly – even now a 60 per cent loss contrasts with bond prices of about 20 cents in the euro. Hedge funds have reportedly scooped up certain bonds in the hope of free-riding their way to full repayment while other investors suffer.

The most intriguing questions come out of how the PSI deal will affect the ECB and the International Monetary Fund. The ECB is the biggest single holder of Greek bonds.

Because of the PSI’s voluntary nature, the ECB has been able to keep its holdings out of any deal. That costs Greece tens of billions of euros in foregone debt relief.

But it also provokes a fierce reaction among the private sector bondholders expected to take the pain. One, Madrid-based Vega Asset Management, complained in meetings of the steering committee of creditors about the ECB refusing to accept losses on its own bonds.

The current deal is only likely to heighten questions about the ECB’s stance. Greece is likely to copy the recommendations of one of its lawyers, Lee Buchheit, and insert collective action clauses into Greek bonds retroactively. CACs, as they are known, allow a bond’s terms to be modified if a strong majority – often two-thirds or three-quarters – of bondholders agree. The change would then be binding on all parties. The problem with this is that the ECB would theoretically be subject to any change through the CACs as well. But the ECB has certain weapons that other bondholders do not have. First, it could try to have its holdings somehow excluded from having CACs inserted. More importantly, it is propping up the Greek banking system through its various liquidity measures, giving it a very powerful weapon in negotiations with Athens.

Some bondholders say they have proposed a potential compromise under which the ECB would accept it would not be paid back in full but would not lose money.

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