Here’s something to keep in mind while eurozone ministers try to nail down the specifics of giving the European Stability Mechanism seniority over other creditors.
From the 2003 Isda credit definitions document — which sets out what exactly can be deemed a ‘restructuring event,’ which would trigger payouts on CDS:
(iv) a change in the ranking in priority of payment of any Obligation, causing the Subordination os such Obligation to any other Obligation;
Which might suddenly make that ESM seniority trick rather difficult. Or not. The monetary union did, after all, effectively manage to pull off the trick with Greece earlier this year. In the meantime though, rating agency Standard & Poor’s is already palpitating over consequences of the new-fangled ESM, even ahead of bond markets.
A point aptly made by Nomura’s European rates team on Monday:
There seems to be continued fallout from changes in language of the upcoming ESM (replacement to EFSF) and its apparent “preferred creditor” status. While this has no legal meaning, the move has caused some concern, first with the ratings agencies. S&P put Portugal, Greece and Ireland all on ratings watch negative only because of this change of tone (perhaps a shot across the bow of EU policymakers – if they truly intend to make this change, bond markets may very well take the agency’s cue and react). While there have been no legal documents thus far issued, any move to legislate explicit seniority for ESM would be a trigger to most CDS contracts.Moreover, as the Eurogroup press release of 28 November states that the ESM will be junior to the IMF, we note that the EU’s bilateral loans to Greece have the same effective ranking, but with no explicit mention of seniority, are neither a major source of ratings agency concern, nor a trigger to CDS.
While there is concern of a possible two-tiered bond market with collective action clauses (CACs) and private sector burden sharing only to be introduced into new bonds as of 2013, and old bonds possibly grandfathered and not participating in any possible workouts, we note several points against this possibility. First, to force sovereigns to issue subordinated debt which could trade at substantial spreads to now-outstanding (senior) debt would make funding costs rise even for countries not at serious risk, and would do more harm to those countries at risk. Second, as old (local market) bonds are easy to change by act of parliament, it would be feasible to bring them in line with new bonds on an EU-wide basis. Thirdly, the press statement move to make the new ESM junior only to IMF loans does have an impact on old bonds, and while this does not explicitly mention burden sharing, the move to subordinate is one step closer to resolving this conundrum.
Some would accuse the ratings agencies of helping to fan the crisis (and opinions are divided in Rates Strategy alone), but it appears that in this instance, the agencies may have the bond market’s interest at heart. Focus on issues of subordination may help to fuel ongoing discontent and the off-chance that this leads to another sell-off may cause politicians to tone down their proposals yet again.
Watered-down debt restructurings by market definition reaction?
Perish the thought.
Related links:
That Grεεk CDS trιggεr – FT Alphaville
Eurobonds are among us - FT Alphaville
Burdensharing then and now - FT Alphaville