Possible Outcomes of the Greek Debt Swap

In recent days there have been indications that maybe Greece and its official sector creditors have pushed demands too far and as a result private investors are reluctant to sign up for the PSI deal, which took seven months to finalise. In this document we discuss what could happen in different scenarios including if the thresholds put forward by the Greek government are not met and how the market might react.

The invitation expires at 21:00 CET on 8 March but we do not know how quickly thereafter the result will be released. Settlement is expected to take place on Monday 12 March for domestic law bonds.

There are three main scenarios.
1. If more than 90% of the aggregate face amount of all bonds selected to participate in the PSI accepts the offer, then the Greek government will “complete the exchange of all bonds selected to participate in the PSI that would be bound by the proposed amendments”. The proposed amendments include collective action clauses (CAC), so this implies that all bonds should be expected to be included in the debt swap. Some bonds issued under foreign law may not be included. The application of CAC causes credit default swaps (CDS) to be triggered.

In this scenario, the market is likely to react positively to the news that the Greek debt has been substantially reduced in an orderly fashion. Following the debt swap the debt to the private sector would be little more than EUR100bn and the interest on this only about EUR2bn. In other words, if Greece has to default again in a few years time (which is plausible), it would probably have to default on the official creditors instead. Defaulting on the private investors would give limited relief. Thus, going forward Greece would then matter much less for financial markets, which is in itself a positive.

Markets may react negatively to CACs being used and CDS being triggered. The PSI presents a model for other countries, no matter what politicians tell us and, in this respect, it is bad news that a “voluntary” PSI is not in any way voluntary. The triggering of CDS may also cause some nervousness, although it is well understood that the net amount is limited (EUR3-4bn). The gross amount is substantially greater. The application of CACs is also likely to cause a number of lawsuits in the aftermath of the debt swap. From a market viewpoint, the application of CACs is not only negative, as it helps to reduce the Greek debt further and thus reduces the risk that private investors will have to face a PSI II.

The CACs can be applied only if at least half of the aggregate principal amount
submit participation instructions and at least two-thirds of these consent to the
proposed amendments. The Greek Republic then decides whether to put the
amendments into effect. We expect it to do so.

2.If the participation rate is between 75% and 90% then the debt swap may proceed after consultation with official creditors. This may cause a period of substantial uncertainty until it is announced whether the debt swap will take place or not. This might be announced at the same time as the participation rate but negotiations with the EU and IMF may take some time, so this could delay the announcement of the participation rate. We expect markets to begin getting nervous if we approach the weekend without knowing the result of the PSI offer.

We think that in this scenario the Greek government will be able to strike a deal with its official creditors and go ahead with the debt swap.

It is not clear whether the Greek government will activate the CACs in this scenario. The wording seems to indicate that it might not: “the republic, in consultation with its official sector creditors, may proceed to exchange the bonds without putting any of the proposed amendments into effect”. However, the Greek finance minister Evangelos Venizelos has said “with a near universal participation, it is not necessary to activate CAC but this clause exists and we are ready to implement it if necessary”, i.e. a low participation ratio should increase the likelihood that CACs will be used.

If we get a period of elevated uncertainty (waiting for the results and whether the debt swap will take place), it could cause a negative market reaction (stocks down, peripheral spread widening, EUR/USD weakening). That much of the debt has already been written off (three-quarters of a Greek default is already priced in) and we just had the LTRO II flooding markets with liquidity may help to dampen the negative effect.

If the participation rate is below 75% and the Greek government has not received consent that enables it to complete the debt swap for at least 75% of the eligible bonds then there will be no voluntary PSI. This would cause substantial uncertainty and a more significant negative market reaction. It could take some time before a plan B is ready. A forced debt restructuring agreed with the EU is the most likely outcome – possibly with even harsher terms for private investors than the PSI. In this scenario, the IMF might be unwilling to increase its lending to Greece and it is likely that Greece would have to tighten fiscal policy even more. In this scenario, it cannot be completely ruled out that Greece would undertake a hard default, that it would receive no more funds from the EU and that it would have to balance its budget almost instantly.

Will the PSI deal pass?
We expect the participation rate to be between 75% and 90%, i.e. we see scenario two above as the most likely outcome.

It seems likely to be difficult to get a high acceptance ratio. In our view, many smaller investors will probably say “no, thanks” but most of these matter little for the overall participation rate. The bigger European investors are more or less forced to participate (comparisons with the Spanish inquisition kind of say it all) and 12 out of 13 members of the creditors’ steering committee (which holds about 20% of the eligible bonds) have already signed up and Greek banks are expected to do so as well. However, even Greek pension funds are reluctant to do so and non-European investors may prefer a wait-andsee approach. The ECB and national central banks have swapped their bonds and do not count in the participation rate.