Back on May 11, we took a close look [10] at what a Greek default to the IMF would mean in terms of the country’s obligations to its other creditors.
At the time, it appeared as though Greece was set to default on a €750 million payment to the Fund, so naturally, we were curious to know what the ramifications of a default might be. A day later, we discovered [11] that Varoufakis had in fact orchestrated a deal whereby Greece was allowed to use its SDR reserves to make the payment, a move which amounted to the IMF literally paying itself.
That bought Greece around three weeks and the decision to bundle June’s payments bought three more, but now, with PM Alexis Tsipras having called for a referendum [12], with EU officials and finance ministers having finally thrown in the towel [13], and with Greek depositors draining the ATMs [14] at a frantic pace, default is now all but certain on Tuesday and so the focus has suddenly shifted back towards what happens if Tsipras doesn’t cut Christine Lagarde a check by 11:59 on June 30.
As we’ve discussed at length, Lagarde can, if she chooses, delay a technical default by 30 days by not sending a formal notice of default to the IMF board. Regular readers have been well aware of this for some time now as we discussed it [15] exactly one month ago today. Unfortunately for the Greeks, Lagarde recently indicated she isn’t likely to go that route and will “notify the board promptly” if payment isn’t made. Here's Bloomberg on the consequences:
A possible Greek default on debt due to the International Monetary Fund next week would trigger cross- default clauses on 130.9 billion euros that Greece owes the euro area’s temporary rescue facility, a European Union official says.
Should IMF Managing Director Christine Lagarde tell her board that Greece defaulted on a 1.5 billion-euro payment due on June 30, the European Financial Stability Facility would have to decide among three options: to claim the funds that Greece owes the EFSF; to waive the EFSF’s right to the money; or to invoke a “reservation of rights” that would avoid an immediate claim while maintaining the EFSF’s option to take such a step, the official tells reporters in Brussels on the condition of anonymity
EFSF Chief Executive Officer Klaus Regling would have to make a recommendation to the rescue fund’s board of directors, who are deputy finance ministers from the euro area: official
And here, as a reminder, is how Deutsche Bank explained the situation last month:
IMF loans do not include any formally defined grace period, with fund staff required to send an urgent cable demanding payment to the Greek authorities immediately. This is then followed by a formal notification by the IMF Managing Director to the Executive Board of the failure to pay. It is this notification that is defined as an event of default in Greece's EFSF and other official-sector loans, triggering cross-default. If this materializes, European creditors then have the right (but not the obligation), to accelerate EFSF loans, causing them to be immediately payable. In turn such an acceleration event would trigger cross-default and potential acceleration in the post-PSI Greek government bonds. The timing of the IMF notification letter is itself a political decision, however, as is the decision to accelerate EFSF loans. IMF guidelines suggest the notification to the board happens in a month. Our understanding is that the notification period may be flexible, with some reports last week suggesting that the Executive Board has requested that this notification happens sooner in the event of a failure to pay from Greece.
For those who demand still more granular details about which defaults trigger accelerated payment rights for whom and when, here is the complete visual breakdown courtesy of Barclays:
[16]
So as you can see, not only would a publicly acknowledged default to the IMF trigger accelerated payment rights on EFSF loans, but would "very likely" tip over the EU loan domino and after that, it's on to the ECB's SMP holdings (note that the profits from these bonds were included in Friday's memorandum outlining possible sources of funding for Greece) and then to what would likely be a very messy discussion about whether a CDS-triggering 'credit event' has occurred.
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Bonus: Deutsche Bank from early this morning (prior to Eurogroup) on the "big uncertainty":
We would consider the recent turn of events as a particularly negative market outcome.
First, the Greek Prime Minister took a significantly critical tone of the proposed creditor agreement, signaling he would campaign for a "no" vote. Tsipras said that the aim of some of Greece's partners is to "humiliate" the Greek people, and rejected the creditor's proposal as an "ultimatum" that is against European principles and will "undermine social and economic cohesion." The subsequent message was confirmed by numerous government ministers who all said the government would openly campaign for a "no" and were highly critical of the European position.
Second, the referendum will take place after program expiry and the IMF 1.6bn EUR payment on June 30th. Given that Greece likely does not have the funds to repay the IMF on Tuesday, the decision is likely to lead to a non-payment event on the day. Assuming the loan program is not extended, this materially increases the probability that the ECB does not approve an increase in Greek bank's ELA provision as soon as Monday, in turn leading to effective capital controls.
There will be three things to watch over the next forty-eight hours.
First, the European political response. A Euro leaders’ summit may be called at short notice. Similar to the Papandreou referendum proposal in 2012, we expect that Europeans will make it clear that the government's referendum will be equivalent to a question on euro membership. The Europeans will also need to decide on whether to grant a short-term legal extension to the loan agreement. Though we are still waiting for the European reaction, we consider a more likely outcome that the program is allowed to expire: extension requires multiple parliamentary approval processes, and given the tone of the Greek PM's speech it is unlikely that the political appetite exists to grant such an extension. The IMF response will also be important: when and if Lagarde notifies the IMF board of a non-payment event, this will trigger cross-default on Greece's EFSF loans and the EFSF board of directors (the finance ministers) will have the option, but not the obligation, to call these loans immediately due and payable.
Second, the ECB response. The central bank has been holding daily reviews of Greek bank ELA provision this week, and officials have in multiple statements last week made it clear that ongoing liquidity provision is based on a "credible perspective" of an agreement being reached. Decisions are likely to be taken in conjunction with the European political response and program extension this weekend. The situation remains very fluid, but as things stand we consider the most likely outcome being an ECB decision not to raise ELA funding beyond existing levels as of this past Friday, or alternatively an aggressive adjustment in collateral haircuts resulting in an implicit cap at some point next week. The Greek deputy PM has said he will seek a meeting with ECB's Draghi on Saturday.
The third factor to watch will be public opinion polls on the referendum question. So far, these have shown that support for euro membership when an "unconditional" ("simple") question is asked stands at around 70%. However, when this question is made conditional on more austerity, support drops to 55- -65% depending on how the question is phrased. We expect the Greek PM's position and the phrasing of the question itself to likely lead to additional swing towards a "no" vote. This is particularly so as Greek government officials have stated that the referendum will not be on euro membership, but rather the agreement. The extent to which European pressure and the situation of the banking system next week swings the vote the other way remains an open question.
Overall, we expect the outcome to be very close and uncertain. The closer opinion polls are to a “no” vote, the greater probability is the market likely to price to a Greek Eurozone exit.
In terms of timelines, parliament is expected to be called tomorrow where the exact question will be made public. A simple MP majority is needed. It is likely that a referendum is posed as a "matter of national importance" under the relevant legislation, which requires a 40% participation by voters and a 50% +1 majority for a "yes". The PM has stated that the referendum will be on the creditor's proposal, but this has not been made public and does not exist in an official manner. It is likely that this is done so in the context of tomorrow's scheduled Eurogroup, or it may be that the Greek PM publishes an outline. This notwithstanding, pressure from the European side is likely to be intense so that the referendum will be effectively on Euro membership.
In the meantime, the ECB is likely to hold an emergency meeting this weekend to decide on ELA policy. In the event of an effective cap being set, Greek banks' access to liquidity would be restricted and cash withdrawals or deposit transfers above would not be able to continue. Greek legislation allows either the Bank of Greece governor or the finance ministry to impose capital restrictions. The extent to which this materializes will depend on the ECB decision over the next forty-eight hours as well as depositor behaviour. Outflows had slowed down towards the latter part of the week but are reported to have accelerated again on Friday. Deposit behaviour and usage of ATMs this weekend will provide an indication of likely depositor behaviour into Monday.
In sum, a very significant period of uncertainty has now been initiated. The question of Greece's Eurozone membership has been officially opened.
