With predictions that this week will be the most important one in the history of Europe’s monetary union, I thought that the time was ripe to ask the Lounge’s informal counsel of sovereign debt experts for their views. Below is the response from Mitu Gulati (Duke).
The Eurozone bailout fund for Greece has not calmed the concerns that the markets have about Greece’s ability to repay its debts. Increasingly, commentators are recognizing that a restructuring of the Greek sovereign debt is likely, if not inevitable. Wolfgang Munchu of the FT said this in last week in a piece titled “Greece’s Bailout Only Delay’s the Inevitable”. Today, Jack Ewing of the New York Times was saying much the same, in “For Greece, Restructuring is No Longer Unthinkable”. In effect, this means that Greece is going to ask for financial support not only from the Official Sector (the Eurozone and the IMF), but also from its private creditors (in the form of the proverbial “haircut”). Private creditors though rarely take debt haircuts willingly. Typically, they fight hard to preserve their hair. The question of how (and whether) they can be forced to take a haircut then will depend on what the Greek debt contracts say. And, if that is the case, why are none of these commentators who think that a default is in the offing talking about what those contracts say?
Looking at the contracts, in theory, should be useful in determining what a Greek debt restructuring would look like. First and foremost, there are these things called Collective Action Clauses. In 2003, they were all the rage in Washington D.C. The US Treasury promoted them aggressively as a cure to the problem of Official Sector bailouts. Prior to the introduction of these clauses it used to be very difficult (at least for US law governed bonds) to get a sovereign restructuring done because the contracts typically required 100% of the bondholders to agree before there could be any alteration of payment terms (including stretching out the time of payment). In effect, the unanimity requirement meant that agreement could never be reached and, therefore, Official Sector bailouts ended up being the only solution. These Collective Action Clauses or CACs, however, would require something between 75% and 66% vote for an alteration of payment terms. The idea was that sovereigns who used these clauses would be able to go to their private creditors and ask for a debt reduction. If the deal was good enough to persuade the relevant fraction of holders, the rest of the holders would be bound. Voila! No more need for big Official Sector bailouts.
If CACs obviated the need for big Official Sector bailouts, why is no one asking about Greece’s CACs? Even the US Treasury, that took all the credit for introducing these CACs in 2003, is not talking about them. As of yesterday, Treasury Secretary Geithner seemed to be encouraging Greece to do everything necessary to go in the direction of the Official Sector bailout. See Andrew Beatty, Pressure Mounts for Swift Greek Bailout, Yahoo News.
But assuming that the commentators such as Munchu and Ewing are correct, as I suspect they are, that the Official Sector bailout is not going to be enough, the question of what kind of CAC clauses Greece used in its contracts will have to be asked. If Greece issued primarily under UK law (from my brief examination of some of the contracts available on public databases such as Thomson, Greece issued at least some of its debt under UK law), then it probably has CACs in many of its debt contracts. That, in turn, means that if it can persuade somewhere between 75% and 66% (depending on the specific clauses it used) of the bonds in principal amount that it is in their interest to agree to a restructuring where payment terms are stretched out a few years, Greece can get itself some relief directly from its creditors. If the alternative for those creditors is that Greece defaults, its government falls, Spain and Portugal also default, their governments fall, and that there is generally financial mayhem everywhere, surely at least the big creditors (who probably also own Spanish, Portugese and other sovereign debt) will at least consider the possibility that it might be best to allow Greece a few more years on its payments. The specific vote requirement in the contracts, however, will be crucial in determining how easy it is for Greece to get agreement on its restructuring plan.
Further, many of the standard UK law sovereign contracts mandate that there be a meeting of the bondholders where the vote takes place. This can be good and bad for Greece. On the one hand, it is bad if Greece offers the holders a crappy deal and fears that allowing the creditors to meet and talk might induce them to form a united front against the proposed restructuring. On the other hand, the meeting provision can be good in that it typically comes with a quorum requirement. If the quorum (let us assume it is 50%) is not met, then a subsequent meeting will be called where the quorum requirement is reduced (in effect, meaning that the vote required for the restructuring is even lower – in theory, Greece could do its restructuring with less than a 30% vote).
Nothing I have said should come as news to the debt experts at the IMF, the ECB, the legal departments of the big creditor institutions like PIMCO and (hopefully) in Greece’s external debt management office. The fact that we have not heard a peep about the contracts from these experts and the reporters they talk to makes me suspicious that there is something wrong. Maybe the Greek CACs don’t work for some reason? I remember the guru of sovereign debt contracts, Lee Buchheit, once saying something along the lines of: “no one looks at debt contracts until they are staring at the abyss”. My question to Lee now is: In Greece’s cases, haven’t we been staring at the abyss for some weeks, if not months, now?
And it is not just the CACs that the smart money should be interested in now. There are other questions that Greece’s legal advisers should be asking. For example, can Greece promise creditors a security interest in its gold reserves, for example, in exchange for a lower rate of interest? Typically, such a move would be prohibited by the standard negative pledge clause. But maybe Greece’s negative pledge clauses allow some leeway? Alternatively, Greece could promise new creditors revenues from certain streams of tax revenues. Those promises, if not barred by the negative pledge and pari passu clauses, could also produce new debt at a lower interest rate for Greece. A third question is What portions of its debt can Greece stretch out the payments on without triggering cross default clauses in its other bonds? The answer to this question will depend on how the cross default clauses were drafted (and, typically, the definition of External Indebtedness in them). And so on and so forth. Again, I’m back at the question that I started with. Why are the experts not talking about the terms in these contracts?
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