Greece’s default gets messier

By Felix Salmon
February 28, 2012

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.


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Would it be fair to say that the first time any of the CAC bonds was favoured over a non-CAC bond, the non-CACs would be de jure subordinate? It sounds like if they don’t get enough participation to force full participation then the Credit Event is just a matter of time.

Posted by voodoobunny | Report as abusive

What makes this even messier is that the ECB is taking the “profit” it is making on the difference between the below-face-value price it paid for the bonds and the face-value price it is getting back from Greece and donating that “profit” to Greece. Which means, in effect, that it is not really getting a better deal than the private creditors. I don’t understand what possible reason the ECB has for first poisoining the market by forcing this de factro subordination and then not making any money out of the havoc it has wrought.

Posted by DCWright | Report as abusive

DCWright- can you tell the difference between a 70% writedown and breaking even? If so, why did you make the comment that you made?

Posted by johnhhaskell | Report as abusive

Aren’t you only describing half of the process here, that this is a mechanism by which Greece has debt written off by the ECB et all, using some three way gimmick? If all your doing is talking about one step in the process as if it is all the process there is, then you might well form the conclusion you have. I’m just saying, I think you’ve forgotten something…

Posted by FifthDecade | Report as abusive

“While the ECB exemption was understandable, on the grounds that the ECB was part of the Troika…”

Nothing to do with the Troika, the ECB is not in position to exchange bonds with Greece as this would be direct monetary financing prohibited by statutes, same for the National central banks. EIB is different, it has de jure preferred creditor status by agreement with some countries to which it lends, it also owned by govt. some of them (EZ) funding Greece that would have to recap the EIB if it took (greek related) losses. It serves no purpose for the EIB to take losses and wouldn’t improve Greece position in any way since these losses would be charged back to Greece.

Posted by alea | Report as abusive

I believe that a number of private creditors are holding back in order to force the CAC and a credit event if the ISDA does not rule in their favor.

What Europe has done is created a bifurcated market for European sovereign debt where public holders will be treated differently than private holders creating two risk profiles depending on who is the buyer.

This will cause European yields to rise in the private market as everyone takes into account this new angle to credit risk.

Honestly, if you have to get this cute in crafting a solution then it is not a viable solution.

Posted by dcurban1 | Report as abusive

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