Greece Restructures

Terms restructuring Greece’s 206 billion euros of sovereign debt, which faced likely and imminent default, were formally approved by the necessary 2/3 majority of bondholders on March 9. What now?

First, let’s quickly review how the restructuring — which seemed practically impossible, albeit politically imperative, just a few months ago — came about. The original bonds were, for the most part, governed by Greek law, and contained terms requiring unanimous approval for changes in bondholder rights.

The restructuring terms involved the exchange of the outstanding bonds for (1) new Greek bonds having a face value equal to 31.5% of the original principal amount (and reduced future interest payments), (2) FESF securities having a two-year maturity and a face value of 15% of the original principal amount, and (3) Greek GDP-linked securities in a notional amount equal to the face value of the new Greek bonds issued to each bondholder.

Since it seemed clear that 100% of the bondholders would not agree to a 53.5% nominal haircut (and net present value losses of about 74%, taking into account the reduced future interest payments) — even if the alternative was Greek default and, as a result, perhaps an even greater haircut — to ensure approval on February 23, 2012 the Greek government retroactively inserted in Greek-governed bonds (i.e., 95.7% of the outstanding, the others are subject to foreign law), via law 4050/2012, collective action clauses (“CAC”) reducing the approval threshold from 100% to just 75%.

This hat trick enabled Greece to avoid defaulting (for now) while at the same time reducing its ultimate payment obligation (74%!) with less than the originally-contracted unanimous approval. It’s true that inserting the CAC in a manner which led to all of the bondholders’ payment rights being reduced constituted sufficient basis for a Restructuring Credit Event to be declared by the ISDA Credit Derivatives Determinations Committee and thus a CDS auction (which took place on March 19, 2012). However, neither the CAC itself nor the declaration of a Restructuring Credit Event constitutes a payment default for purposes of cross-default clauses, and thus (again, for now), it seems that a wide scale acceleration/default of Greece’s outstanding debt has been averted.

One could argue that inserting a CAC is unfair, although in essence it simply democratizes bondholder decisions, allowing a majority to rule. (Emerging markets have included CACs in their sovereign debt for a while, and current EU proposals foresee doing so as a matter of course in euro government bonds issued after 2013.)

More significant from a legal standpoint is the retroactive effect of the law, which can easily be seen to constitute a prohibited taking of private property, both under the Greek constitution and the European Convention on Human Rights. Accordingly, it seems that litigation contesting the constitutionality of the retroactive CAC insertion by Greece is possible, if not likely.

Article 17 of the Greek constitution is clear: “No one shall be deprived of his property except for the public benefit which must be duly proven, when and as specified by statute and always following full compensation corresponding to the value of the expropriated property.” Although the CAC insertion could be argued to have been “for the public benefit,” in the sense that it was necessary to avert the certain disaster that would have been caused by a massive Greek default, by its terms the restructuring involved less than “full compensation.” That said, since the constitutionality of the 4050/2012 law will be judged by Greek courts, a finding in favor of dissenting bondholders might be hard to obtain, regardless of the merit of their position.

At the European level, the law is just as clear: the European Convention on Human Rights (article 1 of Protocol No. 1) states “Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.” Although Europe’s interests are aligned with Greece in this regard, there seems a slightly better chance that the validity of the retroactive law might be found wanting by the European Court of Human Rights.

The new bonds and securities issued as part of the restructuring exchange will be subject to English law, which would not allow a retroactive insertion of a CAC clause, so one would hope that this issue will not repeat itself for the new Greek debt. Whether Greece could pull another rabbit out of its hat — e.g., by making it illegal to repay amounts under the new securities — merits close consideration by those exposed to such debt.