Out, erm, yesterday. The term sheet for the ESM.
Details of the European Stability Mechanism, released on Tuesday, promptly sent European peripheral bond yields in a reverse tail spin. As we’ve noted before, the big aim of the ESM is to force the private sector to share in debt losses — which is a nice way of saying it will allow sovereigns to restructure or even (gasp) default once the thing comes into effect after 2013. And in the meantime, there’s lots of talk that Greece or even Ireland, could try to restructure their debt ahead of the 2013 date.
Now there are things to protect investors from just this sort of thing. They’re called CDS contracts, and in theory they’re meant to be triggered by Isda-defined ‘credit events.’ Last week an Isda committee determined that the Irish bailout did not constitute a credit event under its terms, even though the IMF loan effectively leaves private bondholders subordinate to the intergovernmental organisation.
The decision was pretty reasonable, actually.
Here’s Will Porter from Credit Suisse to explain:
The rationale for a CDS contract is to provide protection for a loss on the underlying debt. Ireland has not restructured its debt and Irish government bondholders have not to date been impaired by the country’s bailout package. (The same is obviously not true for the sovereign’s decision to provide widespread guarantees to the banking system…) The IMF provides support to countries in financial difficulty exactly so that they can avoid failing to pay on or restructuring their debt. The IMF loans to Ireland provide additional credit support to the sovereign so that it has the space to sort out the banking system. This is distinct from a subordination of bondholders that is not in their interest; we therefore do not believe this should trigger the CDS.
The ESM, however, is an entirely different kettle of financials. Like the IMF, it has explicit preferred status. But its CDS situation, so to speak, could be very different.
Just to repeat, the Irish bailout via the IMF/EFSF, believe it or not, did not explicitly harm bondholders. The ESM, with its emphasis on restructuring, is different.
So are CDS payouts under any ESM-bailed out eurozone country likely?
In theory, yes. But there’s something else going on in the convoluted machinations of eurozone debt crisis reform. European regulators hate CDS contracts — really hate. In fact they largely see them as purely speculative tools — and letting them ‘work’ as intended would simply be rewarding all those evil speculating spivs and potentially setting the stage for another financial attack on the eurozone.
It’s a point not lost on CreditSights’ David Watts:
… EU Politicians’ low opinion of the CDS market was underlines only two weeks ago by the European Parliament voting in favour of banning naked CDS short selling on sovereigns. This comes after repeated complaints from officials across Europe on the CDS markets since the Eurozone crisis began … These views make us wary that EU politicians, if they decide that a Greek debt restructuring is the only option, may try to structure one that does not trigger the CDS…
That’s easier said than done, of course.
But perhaps not impossible. There’s still that 2010 paper conveniently titled ‘How to restructure Greek debt.’ In it a law professor and a lawyer discuss how the Greek government could change the local law to introduce Collective Action Clauses into their existing debt. CACs, you’ll remember, were one way of allowing losses on bondholders — though so far they’ve been touted as a feature of future debt.
Needless to say changing the law to create a restructuring that wouldn’t trigger CDS contracts would be legally messy and controversial for investors. And CDS are privately negotiated contracts so bypassing them entirely will be tricky.
In any case, eurozone peripheral bond yields continue to surge on Wednesday. The Irish 10-year is through 10 per cent, Greece is over 12 per cent, and Portugal — which looks set to be the next IMF/EFSF bailed-out nation — is above 7.5 per cent.
Their CDS spreads (for what they’re worth, ha) look like this, via Markit:
The ESM term sheet is available in the usual place.
Related links:
That tricky ESM seniority – still tricky – FT Alphaville
Greek debt: restructured - FT Alphaville