Thursday 23 February 2012

Did the ECB exchange the GGB in the SMP?

Did the ECB get rid of the GGB?
Last week it Die Welt reported that the ECB exchanged (or swapped) the GGB they own in their Securities Market Program (SMP) with new Greek Bonds ahead of the PSI. As yet however, there has been no official announcement of the exchange or denial of it. Given the fact that nothing has been leaked as yet, I remain sceptical about this exchange and how it was done if it was done at all. So the question is:
Did the ECB exchanged the Greek bonds or not as yet? There are many hints that point towards a NO answer:
  • There was no official announcement and no official or unofficial leaked document.
  • This is a large transaction and it involves the issuance of new Greek Bonds in order for the exchange to take place.
  • Where are the ISIN’s and the terms of these bonds? This is particular important as investors need to know the Terms and Conditions of the new Bonds to gauge if they, for example, have preferred status. If this is the case then they would subordinate everyone else. Investors need to know.
  • The ECB could not act in such an irresponsible way. ECB is bound by Market transparency when it comes to transactions.
  • The PSI was sanctioned by the Eurogroup this Monday and the Greek parliament is passing the PSI law only today. I doubt if the ECB would have done this exchange before the official sanction.
  • Last but not least is the Greek law that says the following (my translation): 
    • 1d) As “amendment” of the Bonds, we mean the change of the Terms or the addition new Terms, in of one or more of the chosen Bonds or the exchange of the Bonds with one or more of New Bonds.
Probably the last sentence refers gives the legal go ahead for the exchange to proceed with the ECB and not to the real PSI. 
This leads me to guess that the ECB still owns the Greek Bonds but most probably it is going to get rid of them in the next 48 hours for the PSI to start. If that is the case then what is the least problematic way the ECB and Greece can do this?I suggested that probably the ECB would do a Euroclear exchange of the bonds with no transaction taking place. The reason is clear. The ECB cannot buy directly from Greece any bonds as this is prohibited by article 104. Furthermore, they would do two off market transactions with a clear intention of hiding losses and not booking them.

Hence they would probably opt for the exchange. However this exchange is full of dangers. In conjunction with the intention to pass the profits back to Greece through the NCB’s it may be taken as two counterparties doing a transaction with the aim to deprive or defraud other investors. This is how one can look at this transaction. 

A bondholder seeing that the Issuer was about to force losses upon the bondholders came to a secret agreement with the issuer. The investor would forgo any profit on the bonds in exchange for immunity from the restructuring. Furthermore, since she/he is not allowed to give you money directly it would pass the profits to its shareholders as dividends under the understanding that they would pay them back to the issuer using a variety of other instruments.
Trying to pass this from any compliance department in any bank, apart perhaps from the BCCI[1], and you would be thrown out in a millisecond. Yet, this is what is rumoured the ECB has done or will do in the coming days.
The simplest and best way to take the ECB out of the PSI is for the ECB to outright sell back its holdings to Greece. The transaction is an OTC one and the high off market price paid by Greece can be justified due to the size (20% of the outstanding debt) and the strategic need of Greece in acquiring this debt. Though not 100% kosher it is by far the solution with the minimum challenges. However, this would require the EFSF to lend Greece the money to do it. Currently, there is no political will to do so.

 Lastly, it is pure hypocrisy for the ECB to say that they cannot take losses as this could be seen as monetary financing and at the same time paying dividends with the publicly expressed intention for this money to be paid back to Greece. This is usually referred as layering a transaction and it is not recommended unless you have immunity from prosecution. 

ECB’s Preferred what exactly?

The Eurogroup in its Monday’s statement promoted the ECB as a preferred something. Here is the exact text: 
“The Eurogroup takes note that the Eurosystem (ECB and NCBs) holdings of Greek government bonds have been held for public policy purposes.”
Here lies a very big issue. The ECB is not a preferred creditor of Greece or any other country. Why? Because it is NOT ALLOWED to be a creditor of any country and under any circumstances, no matter what (article 104). So it cannot be preferred nothing! I hope they included the NCB holdings by mistake as this would mean that even bonds held for non-monetary policy are included.

The only other option is for the ECB to assume the status of a preferred bondholder! The ECB claims that they bought the GGB as part of their monetary policy mandate. Yet, buying bonds outright was never in the list of monetary tools to start with and we all know how they tried to avoid this in the first place. Furthermore, as far as I know there is no provision in the bond’s contract that differentiates holders according to their investment aims and incentives. It is like two customers buying the same car from the same dealer under the same contract guarantee and when a factory fault is identified the dealer only reimburses you (because you are a cousin) and not the other. Even car dealers usually do not get away with this.

The Eurogroup is granting the ECB something that either makes no sense (preferred creditor) or something that may have exceeded the borders legality. Article 9 of EU 563/2008 (on Contractual law) allows for countries to suspend many things in their laws but the ECB is not a country.

[1] BCCI collapsed in 1991 after massive fraud and laundering was “discovered”. CIA and Oliver North (Iran-Contra scandal) had accounts with the bank among other reputable clients like Noriega, Saddam Husain etc. The actual story dwarfs John Le Carre’s imagination.