Wednesday, 28 November 2012

Eurocouncil Bond risk. A new type of bond risk.

It is now clear that holding European government debt poses more dangers than previously thought. The collective action of Europe can influence all the national bond markets introducing a new type of risk the “Eurocouncil bond risk”. Thus a nation’s government bonds in some ways have become Eurobonds. This became apparent following the Greek PSI that used EU’s article 9 of 593/2008[i] . Now the Eurogroup wants to buy back 30 or more billions of Greek bonds without moving the market. The Greeks say that the appetite increases as you start eating. Europe’s politicians started the process of passing the blame to everyone else but themselves and they like it. One should expect more meddling and messing.
According to the decision taken by the Eurogroup on Greece, Europe and the IMF would decide on the 13th of December on the disbursement of the 43.7billion. Apparently, Eurogroup’s approval hinges firstly on the approval of the national parliaments but more importantly on a “review of the outcome of a possible debt by back by Greece”. Although we would be very surprised if the money is not given the debt buy-back is riskier for many reasons.

1.     Although there is no condition on the buyback to be voluntary or coercive, one has to note that, these post PSI bonds are under English law and as such, Greece cannot play the same trick they used for the PSI. In other words Greece cannot force bondholders to sell at a particular price. So there has to be an agreement. Unless Greece threatens bondholders with a moratorium and default few independently minded bondholders would sell at the price of 28% (price of series to 2042 before the decision) when the market ticks higher. The only other persuasive argument would be for European finance ministers and in particular for the Greek one to arm-twist their banks and in particular the Greek banks into selling their holdings at this price. In this case the effective loss on the original Greek bonds would approach 80%. This is a massive haircut. Nice trade if you can do it even nicer if you can appeal to the noble feelings of self-sacrifice.   
2.     The buy-back is going to be conducted by Greece. This is a grey area as Greece currently does not have the necessary funds to complete such a purchase. An alternative would be for EFSF to issue bonds and the proceeds to be used for the buyback. This is a rather long process. The other way would be to exchange the Greek GGB with T-bills issued either by the EFSF (or the Greek version of it) or even by new short term notes issued by Greece with a guarantee attached. Of course Greece can use other means, like de-listing or other poison pills to “gently persuade” bondholders to sell but we doubt if there is enough preparation or time to start such a process/dialogue.
3.     If the buy-back is done by one entity then theoretically they could form a necessary majority to activate once more the Collective Action Clauses and force any hold outs into this debt swap or sellback. However, that entity cannot be Greece as this is not allowed. Furthermore, it would be seen as a dirty trick to cheat investors. This would probably be successfully contested in the English courts in light of the recent decision on Anglo.
4.     The original proposal also includes the buyback of the PSI hold outs but even if it happens the benefits would be minimal as there is only 3-4billion still outstanding.
In conclusion, the debt by back would probably be done on the Greek bondholders (banks, funds etc) and few European bondholders amenable to altruistic arguments by their political masters. How many bonds can be restructured this way? Counting only the Greek holdings a figure close to 25-30billion is doable. This would represent a saving of 17-20billion on the national debt. One question that remains is where these bonds are marked by the Greek banks. If Greek banks marked to market their nGGB (new GGB) holdings then they would suffer no additional losses due to this. If on the other hand they have them booked at Par then all the benefits would be negated by the increase in capital injection by the state. As for the Greek pension funds, their massive losses and funding gaps do not count in the Greek debt. So it is a free raid on the future pension.
Once more the European governments are trying to mess with the functioning of the bond market. This is a far stronger omen than anything else on what is going to happen to other government bond markets like Spain’s, Portugal’s, Italy’s and perhaps even France’s. L'État, c'est moi as Lagarde would have said if she lived at the time of Louis LIV.

[i] Article 9. 593/EU.Overriding mandatory provisions are provisions the respect for which is regarded as crucial by a country for safeguarding its public interests, such as its political, social or economic organisation, to such an extent that they are applicable to any situation falling within their scope, irrespective of the law otherwise applicable to the contract under this Regulation. 2. Nothing in this Regulation shall restrict the application of
the overriding mandatory provisions of the law of the forum.