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How will the Greek restructuring work out?

The manner in which the Greek restructuring deals have been carried out, and the preferred investor status given to the ECB and the central banks of other European countries, has left the private sector badly burned. Will this lead to a reluctance from private investors to re-enter the country, or the eurozone in general, thus hindering its recovery?
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How will the Greek restructuring work out?

In whatever way the eurozone crisis is resolved, the repercussions in the sovereign debt market will be felt for years to come. Due to their exceptional and unprecedented nature, the various initiatives taken over Greece hardly found any grounding in the broad principles used in previous restructurings.

Any deal within the eurozone was always going to be challenging, of course, given the infancy of its institutions and the many problems posed by multiple decision makers deciding the future of one currency. The pressing issue as to whether multilateral bodies such as the European Central Bank (ECB) or the newly created European Stability Mechanism (ESM) should have preferred creditor status – on the same lines as that granted to the International Monetary Fund (IMF) – continues to be unclear. There are also concerns about the complexities of having numerous parties involved in the negotiations, the lack of transparency, and the retrospective imposition of collective action clauses (CACs). 

Traditionally, it would be the role of the IMF to provide the vast majority of official support in a sovereign debt work out. In Europe, this was not the case, and instead a multitude of public sector creditors took the stage. On the one hand, private sector investors and advisers believe that a preferred creditor status extended to so many official creditors will deter much needed private investments in Greece and the eurozone in general in the future. On the other hand, some believe that priority is necessary to guarantee emergency measures, whether from the IMF or other bodies. And they worry about a subsequent weakening of this principle in relation to Spain.

Preferential treatment

The debate on who should bear the costs of Europe’s sovereign debt crisis was ignited by Greece’s sovereign debt restructuring, in which it was not just loans by the IMF, but also eurozone countries’ finance as well as bonds held by the ECB and national central banks that received preferred creditor status. As part of the same deal, under the Private Sector Initiative (PSI), private sector investors agreed to halve the nominal value of their claims and reduce the interest rate payments on those bonds. As a consequence, the majority of Greece’s government debt, standing at more than €300bn at the end of July, is held by the official sector, and therefore by senior creditors. This is something that is seen as a deterrent for new investments, as the private sector would immediately find itself at the bottom of the repayments pecking order.

Philip Wood, head of Allen & Overy’s global law intelligence unit, says that it is unprecedented to have such a large proportion of senior debt left as part of a restructuring. “It’s absurd; it should have been junior, or at least equal. It has a very chilling effect on finance,” he says.

The co-head of restructuring at one international advisor says: “The notion that only the private sector had to sustain the brunt of the pain and the official sector got away with no pain, from a general restructuring perspective, makes no sense.”

In sovereign debt restructurings, no creditor has legal seniority but a de-facto seniority is granted to the IMF and other multilaterals on the basis that they provide new finance at the time of restructuring. Loans extended from eurozone countries could be associated to IMF’s funds, although their relation with Greece – or any other ailing government – is of a rather different nature, as unlike the IMF they do not have an independent stance on the negotiations and would act to support a common economic and monetary area. But the highly contested point was that preferred creditor status was granted to the ECB when it bought Greek bonds on the secondary market, as well as to national central banks’ holdings, as these did not represent new financing – no new money was provided through those holdings.

“The fact that the ECB, which didn’t provide new finance but bought those bonds in the secondary market, and the treasury holdings of other central banks, receive seniority status is totally unprecedented and not consistent with the principles, used in the past, to why creditors should receive senior status in a debt work out,” says an international debt restructuring expert.

Yannis Manuelides, partner at law firm Allen & Overy, adds: “There is an argument to be made that if you stabilise the market you shouldn’t suffer a loss. The counter argument for this is that central banks intervene to stabilise the [currency] market all the time and they don’t ask for counter indemnities for currency losses from the central bank whose currency they’re selling or buying. They just do it because they think it is good for their economies.”

Private salvation

It seems that the private sector’s complaints may have been heard. In July, newswire Reuters reported on plans to further reduce Greece’s debt by between €70bn and €100bn, quoting senior eurozone officials familiar with the discussions, and stating that this would require the ECB and national central banks to take losses on their holdings of Greek government bonds, and could also involve national governments accepting losses. As The Banker went to press, no official announcement had been made.

In mid-2012, a softer approach on the official sector’s claims had already been taken with the lighter conditions attached to the bailout funds for Spain’s banking system. Supporters of seniority for any rescue funds heavily criticised those decisions, however.

The priority initially assumed for the activities of the temporary European Financial Stability Facility (EFSF) and the permanent, soon to be fully operational ESM was called into question at the late June eurozone meeting, where it was agreed that financial assistance to Spain for the recapitalisation of its banking sector will be provided by the EFSF and transferred to the ESM without gaining seniority status.

Economist Nouriel Roubini believes that giving up seniority is a mistake as any rescue money, ultimately financed by tax-payers, needs to be senior. Furthermore, those bail-out funds have been used to maintain banks in private hands, ultimately benefiting their investors. Mr Roubini put it rather more colourfully in a series of messages posted on social media website Twitter after the June eurozone meeting. “Now slippery slope of ESM/EFSF starting to become as junior or more junior than private claims in spite of being DIP [debtor in possession] financing. Stupid path!” said one tweet, followed by: “Official money should always be senior as it is DIP financing in a crisis. So even EFSF, not just ESM, should be senior to private claims.”

Shared concerns

Mr Roubini’s views are shared by others. Citi’s research team, led by chief economist Willem Buiter, states in a note its concerns about an ESM with no preferred creditor status: “we regard any decision to remove the preferred creditor status of the ESM – a decision undoubtedly affected by the adverse market reaction to the announcement of the Spanish bank bail-out – with considerable concern,” the note says. The preferred creditor status of the ESM, says Citi, and the tax-payer protection that comes with it, were key to obtaining support in the first place from those eurozone countries most likely to be net creditors. Mr Buiter and his team believe that lack of seniority would make it more difficult to get approval for future use of ESM resources and expand their limit from the current €500bn.

Similarities can be drawn to the priority the ECB demanded when it created the Securities Market Programme in mid-2010. It acted in an emergency situation to add liquidity to the market and free up investors from their Greek exposure.

“The only buyer of Greek bonds was the ECB, and it was buying bonds from private investors,” says Ignacio Fernández-Palomero Morales, deputy director of debt management at Spain’s treasury. “In my view, this was a kind of bail out of private investors before the PSI took place. The ECB put at risk its own balance sheet in favouring investors.”

Neither the ECB nor Greece’s treasury responded to The Banker’s requests to comment on the subject.

Without precedent

The complexities of the eurozone debacle have made it hard to find any useful comparison with past restructuring deals. The number of interested parties and decision-makers, and their multiple roles – the ECB, one of the creditors, was negotiating with another set of creditors, the private sector, to agree on their haircuts, for example – was at odds with a typical negotiation structure, where on one side sits the debtor and on the other the creditor, while the IMF, in its role as rescuer, would oversee discussions.

The PSI’s technical negotiator, BNP Paribas’s Christopher Drennen, says: “In comparison with previous restructurings, such as in Latin America, the Greek negotiations were extremely complex. In traditional sovereign renegotiations, the IMF would be the key player providing the vast majority of official support. Greece, as a member of both a political and a monetary union, was surrounded by a multitude of official supporter-stakeholders. Many European governments, the European Commission, EFSF and ECB were all negotiating alongside the IMF and Greece in various capacities. This created a complicated decision-making environment for everyone involved.”

Of the past major restructuring deals, Argentina was the most recent prior to Greece and, in that case, the issue of official sector priority was indeed limited to the IMF. Even if Argentina’s default a decade ago still isn’t fully resolved, and the country has yet to regain access to international capital markets, Guillermo Nielsen, Argentina’s secretary of finance during its 2005 debt restructuring and its current ambassador in Germany, found the Greek deal chaotic and politically charged in comparison to the negotiations he led for his country. It is political influence, rather than sovereign debt restructuring principles, that led to the handout of preferred creditor status, he believes.

“[Greece’s sovereign debt restructuring was done] in a cumbersome, politically influenced process and as a result of this, the percentage of official support that has privileged creditor status on the current stock of Greek debt is now extremely high,” says Mr Nielsen. “This in itself precludes the resumption of private capital inflows.”

A retro fit

Another element of the Greek deal has raised tension and criticism. The PSI, which came to life in its second version after many months of heavy negotiations and scrapped initial plans created in the second half of 2011, involved the swap of all Greece’s local law sovereign bonds into new ones governed by UK law – something that is not too unusual and ended up protecting creditors.

The controversial part is that the deal also introduced retroactive CACs, something that European governments are to introduce into sovereign debt issued from 2013, but that were not included in the existing Greek law bonds. This has the effect of imposing the decision taken by a number of bond holders on the minority that disagrees with the terms. Changing the terms of contracts is, of course, something that would agitate any investor. Hedge fund Greylock Capital Management’s president and chief investment officer Hans Humes says that, generally, it has to be expected that heavy measures are imposed under political pressure, but that never in the past has he witnessed what was done with the Greek deal.

The retrofit allowed the restructure of 95.7% of the €206bn-worth of  bonds eligible under the PSI, which included government-guaranteed notes issued by corporates, and self-inflicted a haircut of about half the bonds’ nominal value, which becomes a loss in excess of 70% when cuts on interest repayments are considered. Bonds held by the ECB and national central banks were excluded from CACs.

The coercive nature of those clauses helped in reaching an agreement on the PSI, but the fact that the action was described as voluntary in official statements was not entirely supported in participants’ comments. Commerzbank chief executive Martin Blessing publicly defined the voluntary debt write-down of private sector creditors as “about as voluntary as a confession during the Spanish Inquisition”. Less evocatively, one debt restructuring advisor says: “Despite what some say about the PSI being the best negotiated voluntary restructuring, in my view it’s the complete opposite. It’s a retrofit CAC; it’s the most aggressive stance that a sovereign has taken – certainly in the past 20 to 30 years. It goes way beyond what Argentina or Russia did [in early 2000 and the late 1990s].”

Others believe that the use of CACs – even with a retroactive nature – was essential to the resolution of such a challenging deal. Robert Gray, chairman of the Regulatory Policy Committee at the International Capital Markets Association, believes that introducing CACs in the local bonds legislation was necessary. “The Troika's [the IMF, the European Commission and the ECB] expectations in terms of bondholder participation could not have been met without [the decision to introduce retroactive CACs] by the Greek government,” he says. Mr Gray also serves as chairman of HSBC’s debt financing and advisory group; the bank was one of the two agents called by the Greek authorities to execute the debt swap.

Greece is not the first sovereign to have used CACs in its debt restructuring. The Seychelles and Belize had already successfully triggered them and the Caribbean country of St Kitts and Nevis also used collective action clauses in its sovereign debt restructuring, soon after the Greek deal. Greece, however, was the only case where bond contracts were altered and CACs introduced as part of the negotiations.

Transparency needed

Whether the official sector will end up suffering nominal losses or not, and however the debate on preferred creditor status develops in the European crisis, more transparency will be needed throughout the process. The exact exposure of individual eurozone central banks to Greece, for example, is still unclear. This would help the process for any other possible European bail-outs, and also for Greece’s inevitable second restructuring, which is bound to involve official claims only.

Charles Dallara, co-chair of the Private Creditor-Investor Committee for Greece, which was created by the International Institute of Finance to represent private sector bondholders, says: “Some elements of the Greek agreement were not transparent, and that continues to leave some questions hanging over the deal, especially the treatment of ECB and national central bank involvement.”

Things may improve as existing and new European institutions are forced to expand their mandates and quickly mature. If, for example, the ESM will effectively serve as a sort of European IMF, its preferred creditor status could be rightly claimed. A strong ESM would also move in the same direction of a European banking union, which would ultimately break the co-dependency between governments and countries’ banking systems and reduce contagion between sovereign and banking crises.

The definition of where preferred creditor status should apply is a work in progress, and while keeping an eye on the broad principles of sovereign debt restructurings, the discourse in Europe also needs to be mindful of the effects of any national deal on the rest of the eurozone. Promoting growth and attracting foreign investment, not just budget austerity, are paramount goals. It would be a Herculean task to attract investors to Greek or other ailing governments’ bonds if they could only be subordinate to large existing official creditors.

Further, the Greek deal’s negotiation process has left many investors burned and they may be reluctant to look at the country’s private sector too. The capital needed for the country’s ambitious privatisation plans and more generally for the whole economy may fall very short of politicians’ hopes. “I can tell you, if you talk to investors involved in the restructuring, no one is willing to ever invest in Greece again [until memory fades]; it’s been such a traumatic experience,” says one financial professional.

As the European crisis continues, the principles of preferred creditor status are likely to be challenged further. Views on what role European institutions and European governments ought to play may continue to change.

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Read more about:  Western Europe , Greece , Regulation & Policy
Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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