Is A Greek Uncontrollable Default Inevitable?

It seems our discussions on sovereign litigation 'arbitrage' and blocking stakes among foreign-law Greek bondholders is gathering some consensus among the smarter sell-side research shops. In a note today, recognizing the differences between Greek international-law bonds, Credit Suisse applies their rigorous game theory perspective to the EUR18bn of foreign-law bond holders and the implications on the PSI negotiations. As we have pointed out, and has been successfully traded in the last few weeks, they expect foreign-law bonds to trade at a premium to Greek-law government bonds (just as we also noted we see increasingly in Portuguese bond dispersion) not just for blocking stake possibilities but also as better hedge-protected CDS positions. CS points out that if CACs were introduced into Greek law bonds, this blocking stake in foreign-law bonds will create a much higher chance of a hard default credit event and while UK law bonds won't be protected from a hard default they will at least have CDS trigger protection. Finally, the hope of creating a true Prisoner's Dilemma (where standing alone/holding-out singularly is a sub-optimal strategy) fails dismally as each participant is aware that others (blocking stake foreign-law bond holders) will for sure not participate. Adding to this threat is the current low stress environment, set up by the ECB and its LTRO, which could encourage more 'aggressive' behavior by any player in the game creating higher chances of a hard default by Greece as Troika-deal confidence increases the bargaining power for heavier haircuts and thus - fewer willing participants. What a mess!


Credit Suisse: Greek International-Law Bonds

Based on our analysis, we expect Greek international law bonds to trade at a premium to Greek law government bonds. We think there is a higher chance that, at the single bond level, some of the holders of the former would not participate in a restructuring that could be enforced by the retroactive introduction of CACs into the latter since minority blocking stakes by the private sector might already be in place.

Furthermore, due to their higher CAC threshold it is probably easier for a private investor to build a blocking stake in one of the newer vintage type bonds, which we thus find more attractive.

In addition, if CACs were introduced retroactively for Greek law bonds, we believe there is a good chance that the threshold would need to be set at 66% (or lower) rather than 75%, since the banks have probably sold a large share of their holdings to either the public sector or to investors who do not need to participate in a voluntary PSI. The international law bonds with the 75% threshold should thus benefit on a relative basis.

However, if CACs were introduced into Greek law bonds and minority blocking stakes in international law bonds prevented a full participation by all holders, we would expect that the higher the proportion of private sector hold-outs, the higher the chance of a hard credit event would become.

Furthermore, if the Greek authorities decided to take the route of a hard default, for example, a failure to pay, we believe there is a good chance that the international law bonds would be subject to that as well. We suspect that English law may in the end not prove much recourse given Greece’s financial condition. A minority blocking stake is hence no hedge against a hard credit event, in our view – it merely minimizes the risk of taking a loss in a bond without the CDS triggering.

We do not know if the ECB holding of circa EUR45bn of GGBs includes international law bonds. Given the ECB’s unwillingness to participate in the PSI, we would expect it to sell its stake to participating (private or public) parties if there were a chance of preventing a minority blocking stake.

There is an interesting additional conclusion with regards to the tactic that we highlighted in our latest Flash, which could be designed to ensure a nearly universal take-up in a bond exchange as described by Mitu Gulati and Jeromin Zettelmeyer. In our opinion, this tactic only works if it turns out to be a true prisoners’ dilemma, in the sense that the parties that can decide to participate or not know that they will lose if the other parties choose to participate and one stands more or less alone as a single hold-out. However, the potential existence of blocking stakes and, importantly, the fact that the respective players might be aware of them, reduces the likelihood of anyone choosing to participate out of pure fear that the other players might do so. As a consequence, we believe a voluntary take up can only work if the result from participating becomes more lucrative – in other words, if what the private sector could receive in exchange for its bonds was somehow enhanced in value. Among other things, that could include seniority, legal and jurisdictional considerations. We also think that, as the private sector involvement becomes increasingly punitive, the risk of a non-cooperative strategy decreases, reducing the chance of a voluntary outcome.

Finally, we would like to point out that our Game Theory would suggest that the environment we currently observe, namely a low stress environment, is exactly the type where one would expect “aggressive” behaviour by any player. Therefore, we would not be surprised if a hard default by Greece (i.e., a default where relations with the core break down, endangering the ECB’s considerable additional exposure) is being contemplated a lot more than it was just a few months ago.