An ESM subordination… save? | FT Alphaville

An ESM subordination… save?

Hat-tip to Charles Forelle for pointing out a feature of ESM creditor status that we really should have noted earlier. From the Treaty:

In the event of ESM financial assistance in the form of ESM loans following a European financial assistance programme existing at the time of the signature of this Treaty, the ESM will enjoy the same seniority as all other loans and obligations of the beneficiary ESM Member, with the exception of the IMF loans.

In other words the ESM would be pari passu with bondholders, not preferred over them, if an applicant country already borrows from the EFSF.

You can see how this might be latched on to like a life-raft in the Spanish bank bailout, where fears of subordination are rife. There’s a good chance that Spain would access the EFSF temporarily in June or July. It will take time for states to ratify the ESM. So long as Spain borrows even a tiny bit from the EFSF, its subsequent ESM loans would not be senior, the theory might go.

Interestingly enough at pixel time, Reuters cited an EU official saying that Spain could take ESM loans later on, but these would not be senior. (Which would be news to this European Commission spokesperson cited by MNI, who confirmed that ESM loans would be senior. Could it possibly be that the authorities have no clue here?)

OK. But there is just one problem.

Signing a treaty does not mean the same thing as ratifying it.

Think how many treaties the United States has signed but not then ratified because of Congressional objections, for example.

The two are legally distinct because it is only on ratification (usually by a majority of signatories) that a treaty’s provisions enter into force for the states party to it. Signature can often take place years before ratification.

Throughout all this, incidentally, you have to remember the ESM will be an international organisation backed by treaty, not a Luxembourg private company like the EFSF.

The ESM Treaty section above refers only to signature. States signed the Treaty back in February 2012. At that time Portugal, Ireland and Greece were under financial assistance but not Spain, clearly.

This is either careless or very careful treaty drafting, depending on your point of view.

We suppose it’s entirely possible that eurozone officialdom could just ride roughshod over the signature point, given the problems which they must realise would ensue from subordination. Ultimately we’ll have to wait for the specific ESM loan terms.

But we’ll close by noting even ‘pari passu’ EFSF debt (or ESM debt which might subsequently absorb EFSF pari passu status) has shown signs of de facto seniority in Greece. EFSF loans to Greece were rescheduled before bondholders, but when it came to the PSI, the EFSF did not take write-downs in common with bondholders. Update: Oops! We should have known that until the second bailout, the EFSF didn’t lend to Greece. It received bilateral loans from eurozone states. These were pari passu in common with subsequent EFSF loans to Ireland and Portugal but it’s an important distinction. Thanks to a friend of FT Alphaville for pointing out our error.

Whatever happens, bondholders increasingly have to contend with subordination in eurozone bailouts now.