Friday, 24 February 2012

Europes sleight of hand.

***ISIN for the bonds secretly exchanged with the ECB are GR0108008476 and GR0120005161 ***

The Greek parliament voted yesterday the new PSI/CAC law. It is not a pretty site for investors or the peripheral bond market. There is no more voluntarism. The main points are. 
  •  Only bonds that were issued before 31Dec 2011 would be eligible for the exchange. The Greek government would define, probably later today which of these would participate in the exchange. It only refers to the Bonds under Greek law. The rest (around 18billion) would be dealt separately later in April as they already have CACs.
  • As bond holders submit their bonds they would also vote for the exchange. For the exchange to proceed a 50% is needed of all the outstanding bonds.
  • Furthermore in order to bind everyone to the exchange, a 66% is needed of those who voted. Thus a minimum 33% of the notional can bind the rest. 
  •   The law is treated as “highest public interest” and as such bondholders have no hope of finding justice in Hell.Republic’s courts. That law supersedes everything (Mandatory provisions). According to some legal observers this could be unconstitutional. As the law was passed by a simple majority this argument may gather pace. Changes in the constitution need a supermajority of 3/5. 
  •  Making the law a “public interest” also means that European courts have little power to do much.
The vote is not just about introducing the CAC into the bonds but also activating them automatically once the 66% votes for it. In doing so the Hell.Republic is trying to pass the blame with the bondholders for the coercive nature of the restructuring.
So after all the talk of voluntary participation it comes down to a no-ifs and no-buts restructuring. Small retail bondholders are caught in the restructuring and are bound to lose their savings. The Greek government has expressed its willingness to somehow compensate the small retail bondholders but only in Greece. No details have been published on how this can be done. As for non-domestic retail investors, they would need to lobby their government. For example a German retail investor should ask Mr Wolfgang Schäuble for compensation. 

Market Consequences

The way the PSI was handled by Europe and Greece is atrocious. It started by insisting on a voluntary restructuring. All EU council decisions apart from the last one had the word “voluntary” when referring to the PSI. Then it declared that the ECB is a favourite bondholder and took them out of the process in secret. After that it shifted the blame for a coercive restructuring with the bondholders and used extraordinary legal measures to limit the fallout.
They have shown utter contempt for the market and especially for non-bank investors. While they saved the ECB and threw money to sweeten their Banks the rest of the investors are left to bear the brunt of the restructuring. This is surely a bad blueprint for future restructurings.

In a previous note, I mentioned that international practice calls for the right of the minority holders to be respected. Contrary to this, the rights of the minority are also restricted by making the law a “public interest”. In addition, when invoking the right of the majority, the principle of Good Faith must be observed[1]. In other words, one cannot just by having the majority impose a solution that is unjust and detrimental to some bondholders. And this is exactly the case here. The majority has the duty to consider the welfare of all the bondholders, not just their own. As it stands, the official sector was bailed out only days before the law was passed 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 and smells as if their vote has been bought by the issuer.
Moreover, one can argue that there is collusion between some investors[2] and the issuer to defraud certain small class of investors by invoking the rights of the majority. The law passed effectively only requires a minimum of 33% of the bond Notional to bind everyone.

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) according to press reports was bailed out in total secrecy. This is shameful behaviour and a bad precedence.

We thus expect the market to price the risk of other peripheral countries restructuring in a similar way and also to price the fact that the ECB is now officially a preferred holder. 

Bondholder Reaction

One should not see the end of the story here. Despite the fact that the law invokes the mandatory provisions of Article 9 of EU 563 593/2008 many bondholder still have the power of delaying tactics. For example bondholders can ask courts to rule on the validity and their answer may take time. If the PSI exercise is delayed by more than a week then perhaps this would be enough to derail the whole process. The coming weeks look very intriguing.

[1] “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)

[2] See, Klein & Juhle, Majority Rules: Non Cash Bids and the reorganization sale. American Bankruptcy Law Journal, Vol.84, p.297-326.