The practice of Devil’s advocate goes back many centuries. The origin of the term comes from the Canonization process of the Catholic Church. The church appoints a God’s advocate (Advocatus Dei) that argues in favour of the Canonization and a Devil’s Advocate who promotes the sceptical view. Most recently (2002), Christopher Hitchens played the Devil’s advocate in the Canonization of Mother Teresa. He, by the way, argued that she is fanatic, fundamentalist and a fraud who is responsible for more misery and deaths in India due to her stubbornness in promoting hardship and punishment often resulting in death rather than the emancipation of women.
Jumping forward 10 years, Greece is considering introducing Collective Action Clauses (CAC) in the Bonds under Greek law in order to force a higher participation in the PSI restructuring process. We have argued against this action repeatedly (see previous Notes, and posts). We present a hypothetical exchange between the Devil’s advocate (A.Diaboli, Bondholders) and God’s Advocate (A.Dei, Hellenic.Republic).
A.Dei: The Hellenic Republic has in its
sovereign power the right to introduce CAC even though these do not currently
exist in the Bonds. It is not a Credit event as it does not impair the value of
the bonds.
A.Diaboli: The original bonds do not have this
clause and any unilateral change of the bonds terms by the Hell.Republic that lowers
the value of these bonds is a Credit Event. Academic studies have shown that
the introduction of CAC’s into a Bond’s prospectus results in a higher yield
demanded by investors especially for lower quality issuers such as Greece (See
Eichengreen & Mody[1]
2000). Furthermore, the future rights of
the bondholders are adversely affected just by introducing them. For these
reasons the introduction of the CAC impairs the bonds and as such should be
considered to be an event of default.
A.Dei: The activation of the CAC’s is not a
credit event as it is the bondholders and not the Hellenic Republic who demand
it and not the issuer. Therefore provided the requisite majority is achieved
the restructuring can proceed without a credit event.
A.Diaboli: ISDA rules are very strict. Any
restructuring that is binding to bondholders is Credit event. See section 4.7
of their document[2]. Thus
any activation of the CAC would result in restructuring and thus it would be an
event of default.
A.Dei: Collective Action Clauses are binding
for everyone and invoke the principle of burden sharing in a restructuring.
Furthermore, they stop incalcitrant and malevolent bondholders from disrupting
a fair and just solution for everyone involved. Many investors buy the Greek
bonds with a view of suing the Republic and should be punished for it.
A.Diaboli: A.Dei
is right in saying that the CAC facilitate the speedy and just resolution of a
restructuring. However, when invoking the right of the majority, the principle
of Good Faith must be observed[3].
In other words, one cannot just by having the majority impose a solution that
is unjust and detrimental to some bondholders. The majority has the duty to
consider the welfare of all the bondholders, not just their own. And this is
exactly what is going on in the case of Hell.Republic. As it stands, the
official sector is exempted from any PSI restructuring and the Greek banks
would cover their losses by being recapitalised by the issuer. Similar
assurances have been given to European Financial Institutions by European
politicians. We thus have a situation, whereby, certain classes of investors
(Official Sector ECB, Greek Banks etc) are indifferent to the restructuring
losses. This is by no means a just and
equitable burden sharing. It looks as if their vote has been bought by the
issuer.
Moreover, one can argue that there is collusion
between some investors[4]
and the issuer to defraud certain small class of investors by invoking the
rights of the majority. If the introduction of the CAC by the Hell.Republic is
done at the minimum of 50% (plus 1) rather than a supermajority of 75% or more
that view would be reinforced.
Finally, punishing the investors is not an
acceptable goal for the activation of CAC. As we have argued above, some
investors escape unscathed from the restructuring while others take a big hit.
This is blatant discrimination of investors. Additionally, the official sector
(ECB) may be exempted from any CAC’s effectively subordinating every other
bondholder to the Official sector which is again an event of Default.
A.Dei: The introduction of the CAC would be
done under Greek law and we do not follow the American or other precedents. We
are not bound by any previous rulings or assumed good faith practices.
A.Diaboli: Indeed that may be the case, but
the Hell.Republic does not operate in vacuum. As a western modern state and a
member of the European Union it has to behave accordingly. Failing to do so,
would only damage the credibility of the country and give ammunition to those
who demand its expulsion from the Union.
[1]
Eichengreen & Mody, Would Collective Action Clauses Raise
Borrowing Costs? An Update and Additional Results, http://escholarship.org/uc/item/46p4z4c4
[2] (a) "Restructuring" means that, with
respect to one or more Obligations and in relation to an aggregate amount of
not less than the Default Requirement, any one or more of the following events
occurs in a form that binds all holders of such Obligation, is agreed between
the Reference Entity or a Governmental Authority and a sufficient number of
holders of such Obligation to bind all holders of the Obligation or is
announced (or otherwise decreed) by a Reference Entity or a Governmental
Authority in a form that binds all holders of such Obligation, and such event
is not expressly provided for under the terms of such Obligation in effect as
of the later of (i) the Credit Event Backstop Date and (ii) the date as of
which such Obligation is issued or incurred………
[3] “Power granted in an indenture to a majority of Bondholders
to bind a minority must be exercised in good faith”. ABA Commentaries on
Model Debenture (Sage 99 at US 341)
[4] See, Klein & Juhle, Majority Rules: Non Cash Bids
and the reorganization sale. American Bankruptcy Law Journal, Vol.84,
p.297-326.
