Over the weekend, and before it became a popular topic in the mainstream media and an issue of political debate, UBS first among the "non-fringers" discussed the topic [8]of not only a coercive Greek restructuring (i.e., one in which there is no "agreement" of the bondholders) but that it is, in fact, imminent. Since then, the din over this issue has escalate with reports over the past two days, that Greece may enforce collective action contracts as well as force bondholders into a deal, since various hedge fund hold-outs have been holding Europe hostage, a development foreseen here in mid-2011 [9]. Unfortunately for Europe, which apparently has no idea what is going on, and whoever is advising it financially is certifiably an idiot, the coercive path is precisely what the end outcome may end up being. Naturally, while this is preciseley what should have happened long ago (and saved taxpayers everywhere hundreds of billions in Greek bailout funds), the fact is that it goes contrary to everything the imploding status quo and collapsing ponzi house of cards is doing to prevent an all out catastrophe, as a coercive transaction actually will have unpredictable and adverse spill over effects in virtually every aspect of European financial markets, which in turn will migrate to the US. The good news is that CDS, despite the constant attempts of the crony and corrupt ISDA otherwise, will once again become an instrument of hedging, which ironically in the long run will be stabilizing. But not before some serious short-term fireworks. UBS explains.
- Today Dow Jones reported an unnamed troika official as saying that the Greek government will be “…retroactively introducing collective-action clauses, but not necessarily using them” via the legislative steps needed in order to “facilitate the negotiations with the private sector”. While there has been no confirmation or denial of this statement either from the Greek government or from the troika (of the EU, IMF and ECB), we expect that official and market discussion of CACs and further steps towards coercive restructuring will increase and intensify from this point onwards, leading to a coercive restructuring of some kind around the time of the 20 March bond redemptions.
- If we are correct in this view, the timing of the polemic over Greece turning increasingly towards coercive restructuring makes sense. On Monday of next week troika inspectors return to Athens to begin their next quarterly review and begin discussions over the details of Greece’s second aid package. Early-January was also the date by which the Greek government had expressed a desire to have completed negotiations with the private sector over the voluntary PSI as laid out in the 26 October EU summit statement.
- However, at the time of writing, it does not seem that a deal is close with the private sector, so the statements credited to the troika (which in a similar form also surfaced in the autumn) would appear to indicate the next – logical – steps on the part of Greek government. As we have stated in published research for some time, we believe that a voluntary PSI will likely not take place, owing to the difficulty of achieving sufficient investor participation, and that the negotiations will be abandoned in favour of a coercive move¹.
- With about 94% of its bonds governed by domestic law, the Greek state is in a position whereby it could change the terms its debt relatively easily in order to avoid a technical default within the rules of the bonds themselves. It could pass a law in its parliament which inserted collective-action clauses retroactively into the bond contracts, allowing the proposals of the Greek government to be imposed on all bond holders via the agreement of a certain proportion of bond-holders. In theory, there is no reason why this “deciding” proportion of bondholders would need to represent more than 50% of holders.
- The introduction of CACs in this way would not likely trigger a credit event in CDS contracts - at least in itself, as at that point the bondholder’s cash flows would still be theoretically unaffected. Instead, the CDS trigger would probably be the use of them in any subsequent restructuring
- The framework for negotiation for the Greek government is provided to it by the 26 October EU leaders summit, in which a target of 120% debt/GDP by the end of 2020 was stated with a 50% haircut in the PSI the means to achieve that. However, with Greece missing on both growth and deficit targets, the need for deeper restructuring is continuous. As a result, we expect that the authority will be given to the Greek state for both a coercive restructuring, and – probably – a more extensive one from a decision to do so at another EU summit.
That is the plot. And here is what will likely happen:
- In a coercive restructuring, the consequences of the treatment of euro area central banks could be negative either way. If, on the one hand, the bonds purchased in the Securities Markets Programme (SMP) suffer the same fate as those held by private sector investors, the political consequences of that would effectively be fiscal transfers of tens of billions of euros (whether there is a formal recapitalisation of central banks or not) might be problematic. If, on the other hand, euro area central banks are made whole (for example, by swapping the bonds in advance for cash or for new bonds), then the precedent of Eurosystem seniority may cause significant problems of contagion in the Spanish and Italian bond markets. Indeed, the more bonds bought in those markets for the SMP, the more investors might see themselves subordinated.
As such, the constant fear of what may be announced tomorrow explains the endless drip in the EURUSD, which ironically may strengthen once the overhangs in Europe - the S&P two notch downgrade of France, and the forced bankruptcy of Greece, finanly occur. Then again, in a globalized world in which nobody has any clue what the cause-effect linkages really are, maybe it will simply precipitate the rest.