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Back on February 17, the European Central Bank sprinkled its magical pixie dust on its Greek sovereign bonds, with the effect that they effectively ended up exempt from the restructuring and haircut being inflicted on everybody else. I wasn’t very excited about this development at the time:

On a conceptual level, it makes sense that the Troika — of which the ECB is a third — might be granted immunity from haircuts, in return for providing new money to Greece. On a legal and practical level, however, this is ugly — and you can be quite sure that it’s only going to get uglier from here on in.

Today, we’re beginning to get a hint of the messiness that this decision caused.

First, there’s a formal question which has been put to ISDA’s Determinations Committee, asking whether the ECB magical pixie dust, combined with the passage of the Greek law to allow the haircut, doesn’t in itself constitute a credit event under ISDA rules.

The question takes the form of a single 179-word sentence, which some lawyer somewhere probably thinks is very clever. But here’s the idea: the two events together have effectively cleaved the stock of Greek bonds into two parts, with one part (the bonds owned by the ECB) being effectively senior to the other part (the bonds owned by everybody else). This is known as Subordination, and Subordination is a credit event under ISDA rules.

Now there’s no doubt that the private sector’s Greek bonds are de facto subordinate to the ECB’s Greek bonds now, and that they weren’t subordinate a couple of weeks ago. But so far there’s nothing de jure about this subordination — there’s no intrinsic reason why bonds with CACs, for instance, should be subordinate to bonds without CACs. So my guess is that this request is going to go nowhere, and/or get overtaken by events.

But now there’s news that another European institution has managed to get its hands on the ECB’s magical pixie dust.

The European Investment Bank, owned by the 27-member bloc, is getting exemptions from Greek debt writedowns in the same way as the euro area’s central bank, according to two regional officials familiar with the matter.

The European Central Bank negotiated a deal to avoid the 53.5 percent loss on principal that’s costing private investors as much as 106 billion euros ($143 billion). The EIB, which unlike its Frankfurt-based counterpart represents the entire European Union, also owns Greece’s debt and is sidestepping the so-called haircut in the same way, said the officials, who declined to be identified because the plan isn’t public.

While the ECB exemption was understandable, on the grounds that the ECB was part of the Troika and the Troika is putting up new money here, an EIB exemption is less so. The EIB is not putting money into this latest Greece bailout. Indeed, it represents countries like the UK which are quite explicitly removing themselves from any such thing.

Now, admittedly, the European Commission is a member of the Troika, and the European Commission is the executive body of the European Union, and the European Union collectively owns the European Investment Bank. So this decision is, as the lawyers would say, colorable. But if the decision to exempt the ECB from the Greece haircut was ugly, then the decision to exempt the EIB is, at the margin, even uglier. I’m not saying it’s the wrong decision, necessarily. After all, sovereign restructurings necessarily have an ad hoc, make-it-up-as-you-go-along element to them.

Indeed, if the ECB’s magical pixie dust means that there’s substantially more EU support for this deal, then it might well be worth spreading it around a bit. But at the same time, predictability and consistency are important as well. And both of those seem to have gone out the window at this point. I wouldn’t be at all surprised if ISDA’s Determinations Committee just said “enough already” and declared an event of default. Because in recent weeks private-sector bondholders have been treated in an extremely cavalier manner. And those decisions have consequences.

Source: Greece's Default Gets Messier