Why you should ignore clever ideas in bond documentation

By Felix Salmon
November 27, 2012
Charles Forelle has a very wonky post today under the headline "Greek Deal Could Weaken Private Bondholders", which sounds a bit scary.

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Charles Forelle has a very wonky post today under the headline “Greek Deal Could Weaken Private Bondholders”, which sounds a bit scary. Basically, there was a Clever Idea which got inserted into the documentation governing Greece’s new bonds, but now it seems clever only in retrospect.

The Clever Idea in this case was that when Greece made interest payments on its bonds and on its EFSF obligations, it wouldn’t pay those creditors directly. Instead, it would pay an intermediary, which takes the money and divvies it up between the private-sector bondholders and the EFSF. The effect was meant to be that Greece couldn’t default on its bondholders without also defaulting on the EFSF.

But as we saw in January, Clever Ideas almost never actually help on a substantive level. My favorite example here is the Rolling Reinstatable Guarantee, which was dreamed up in 1999 as a way of ensuring that bond issues by Thailand, Argentina and Colombia would get paid just so long as those countries were current on their obligations to the World Bank. And yet, when Argentina defaulted, the bonds with the RRG defaulted along with all of the other bonds — even as Argentina remained current on its World Bank obligations.

In this case, the problem isn’t that Greece defaulted on its bonds without defaulting to the EFSF. If anything, it’s the exact opposite. The EFSF has basically restructured Greece’s debt, in a manner which would certainly constitute an event of default were it to take place in the private sector. As a result, all those expected EFSF payments have basically evaporated, and Greece needs to pay only its private-sector bondholders.

At the margin, this is a good thing, not a bad thing, for bondholders. It means that Greece only needs to pay them; it doesn’t need to make payments to the EFSF at the same time. So any protection they lose from their Clever Idea is more than offset by the real world cashflow relief that the EFSF has just granted Greece.

On top of that, the stock of Greek bonds is being cut, too, with a €9.6 billion buyback operation which is designed to cut Greece’s outstanding private-sector debt significantly. Once again, that means that Greece needs to find less money to pay off its remaining bondholders — and that’s good news for those who don’t sell their bonds into the buyback operation.

All of which is to say that if you’re looking at debt issues, the important things — who’s going to fund the deficit, how much debt a country has, how much the debt service will cost — will always outweigh any Clever Ideas. In this case, the “co-financing agreement” is now pretty much worthless — but the fact is that it was pretty much worthless all along. If Greece really wanted to find a way of defaulting on its bondholders while remaining current on its EFSF obligations, it could always come up with with such a way. Now, happily, it doesn’t need to worry about such things. Because its EFSF obligations are to all intents and purposes zero, at least for the foreseeable future.


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