Squaring the Greek circle

Posted by Neil Hume on Jun 21 09:13. 12 comments | Share

The ratings agencies have left no one in any doubt where they stand on a voluntary rollover of Greek bonds.Overnight from Reuters:

Fitch Ratings said on Tuesday that it would regard both a Greece sovereign debt swap and a rollover of maturities, More…

The ratings agencies have left no one in any doubt where they stand on a voluntary rollover of Greek bonds.

Overnight from Reuters:

Fitch Ratings said on Tuesday that it would regard both a Greece sovereign debt swap and a rollover of maturities, even a voluntary one, as a default.

Both a sovereign bond exchange and a voluntary rollover would be events considered as a default, said Andrew Colquhoun, head of Asia-Pacific sovereign ratings with Fitch at a conference.

A month ago Fitch downgraded Greece’s credit rating three notches to “B+” and warned it could cut the rating further into junk territory. At the time, the rating agency said an extension of the maturity of existing bonds would be considered a default.

Which, as we know, is problematic.

How do policymakers create a deal that has enough private sector participation, yet still looks voluntary enough in the eyes of the Fitch et all that it does not trigger a downgrade to SD, RD, or even the dreaded D?

In other words, how do you square this Greek circle.

Credit enhancements on the new Greek bonds are one possibility, although the rating agencies haven’t looked too kindly on the topic. Another, according to Jacques Cailloux of RBS, is for euro area creditors to underwrite future Greek issuance via the EFSF.

The only clear cut solution, in our view, is for euro area creditors to underwrite future Greek issuance. The EFSF could be used to that effect with EFSF buying in the primary market any bond that would not be bought by the private sector. In that context, this provides a maximum exposure to the EFSF (essentially the whole volume of redemptions) and leaves private sector participation totally voluntary: no private sector participation would not lead to default and on that basis rating agencies cannot downgrade the sovereign.

An explicit statement from the European creditors that the EFSF would underwrite all the issuance to fund the redemptions has not been stated by policy makers but is in our view the only option to square the circle. This would also provide the important guarantee to the IMF that whatever happens in terms of private sector involvement, the Greek funding gap will be covered. Whether Europe eventually converge to that deal is far from given but today’s [Monday’s] Eurogroup outcome in one step in that direction.

An interesting idea and one that Nomura has also analysed in depth. But as we noted, would it do anything to stop contagion, if the EFSF state guarantees are being called upon so heavily?

There’s another problem — Article 125 of the Treaty on the Functioning of the European Union. Which states:

The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project…

So a straight guarantee might have to be subject to some financial engineering.

Still, the idea of credit enhancing maturing Greek debt via the EFSF guarantee is clearly gaining currency, which makes Monday’s changes to the EFSF’s capital structure worth highlighting. Its working capital will be increased to €726bn – amounting to an over-guarantee of 165 per cent – so that it is able to lend its full €440bn capacity, if needed.

Of course all of this will be academic if the Greeks don’t vote through the austerity or privatisation packages on Tuesday.

On that note here (via RBS) are the key periphery dates to look out for:

Jun 21 Greek government confidence vote (due at midnight on Tuesday, European Time)

Jun 23/24 Heads of State meeting

Jun 28 Greek parliament to vote on Medium Term Plan

Jul 3-4 Eurogroup special meeting (possible decision on the disbursement of the 5th tranche of the loan to Greece)

Jul 11-12 EU FinMins meet in Brussels

Jul 15 Greece T-bill redemption for E2.4bln

Jul 16 EU FinMin, Central Bankers meet in Poland

Aug 20 Greece bond redemption of 3.90% 2011 GGB for E6.61bln.

Related links:
IMF ties Greek aid to bail-out pledges – FT
Jean-Claude Trichet, the almost-Hamiltonian – FT Alphaville
+++Vienna Plus+++ – FT Alphaville
EFSF mission creep, a collateral story – FT Alphaville

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