Understanding the issues around sovereign default

07 Jul 2015 | 6 min read

As the Greek government prepares to restart talks with European authorities, University of London economist, Christina Laskaridis, identifies key issues of contention and concern about a sovereign default in Greece. Tracing a trajectory with legal, financial and political dimensions, she draws on evidence she was called to present to the Hellenic Parliament’s Committee on Public Debt.

Where does the result of the Greek referendum leave us on the issue of sovereign default and restructuring?

The aggressive stance of the European Central Bank (ECB) to not increase Emergency Lending Assistance (ELA) at a crucial time for the Greek economy, triggered the decision to close the banks and impose capital controls. This stance was furthered by the ECB decision of 7 July 2015 to increase the haircut on that collateral Greek banks provide in return for receiving ELA from the Eurosystem—it would be a challenge to interpret this as anything but a signal of the negative stance the authorities took to the outcome of the referendum.

What are the immediate implications of a sovereign default?

Greece’s public debt has multiple structures and falls under different legal jurisdictions, containing different cross-default and cross-acceleration clauses, creating an intricate web of clauses that could trigger demands for repayments of several lenders simultaneously. Key structures relevant to sovereign default include:

  • the 2012 Master Financial Assistance Facility Agreement between Greece and the European Financial Stability Facility (EFSF)
  • bonds held by the ECB totalling €6.7bn, due in July and August 2015
  • Greece’s debt to commercial lenders, which fall due from 10 July 2015 onwards and are varied in their composition

In theory, failing to pay the IMF could create entitlement for some of Greece’s other creditors to declare a default, and activate acceleration clauses—ie demand an immediate repayment of other loans. Under MFAFA (Greece’s second loan agreement) failure to pay the IMF at the end of June 2015 led to the EFSF (Greece’s largest creditor) to opt for a reservation of rights on EFSF loans to Greece, meaning the EFSF will sit tight until developments evolve. However, the real issue now is whether the ECB will step into its role and provide the needed liquidity for the Greek banking sector, or alternatively precipitate a dramatic worsening of the crisis.

What are the key steps and who are the key players in a sovereign bond restructuring?

Sovereign bonds make up a small portion of Greece public debt. As of 30 April 2015, in billion, and as a portion of Greek public debt:

  • bonds—€39.4bn or 12.6%
  • bonds held by European Central Banks (Agreement on Net Financial Assets)—€7.3bn or 2.3%
  • bonds held by ECB (Securities Market Programme)—€19.9bn or 6.4%

The key upcoming repayment date is 20 July 2015, with bonds held by the ECB due. The ECB is Greece’s third largest creditor, with the largest amount of claims on Greece by the end of the decade. With a total of €27bn debt currently, Greece is set to repay to the ECB and other European national central banks €6.7bn in 2015 and €23bn in the next five years. Any deal brokered in the coming days or weeks must address these bonds. These are bonds that the ECB refused to integrate in the restructuring of 2012, and continues to make profits out of Greece as they are high interest bearing bonds. Despite the political pressure to repatriate the profits made on Greek bonds, close to €2bn have been withheld.

Is it possible to estimate the time it will take to agree a restructuring?

Syriza’s stated objective includes ensuring Greek debt sustainability as part of a new programme. Up to now, the lenders hoped to conclude the fifth review of the second programme and leave any discussion about debt restructuring for a later date. The dense and rapid political developments, including decisions to close the banks, impose capital controls, fall into arrears with the IMF and hold a referendum whose results sent a clear message rejecting austerity, have increased pressure on the European authorities reminding them about their November 2012 promises of debt relief. This was further bolstered by the IMF’s debt sustainability analysis (DSA) released on 2 July 2015. The Greek Government is set to restart talks with European authorities on 8 July 2015.

What have been the experiences from other sovereign default events?

The experience of Greece’s 2012 sovereign default was negative. What was described as a success, because it entailed the largest restructuring in history and minimal losses for the private financial sector, was in fact a failure for public finances and—often overlooked—the Greek population.

The result of the private sector involvement (PSI) agreement was that all three rating agencies downgraded Greece to default status. On 9 March 2012 the International Swaps and Derivatives Association announced the exchange constituted a credit event. Widespread fear of contagion did not materialise and the credit default swap contracts triggered were anticlimactic, with eventual settlements small, around $2.5bn. Greece had officially defaulted but the government and domestic and international commentators avoided the D-word as much as possible, presenting its occurrence as a purely technical affair. The lack of credibility in the exchange was signalled by the fact the newly exchanged bonds were immediately trading significantly below par. The ‘reduction’ of approximately €100bn was only conditional on the second loan package—the new funds received by the Troika, far from being used for productive purposes was immediately absorbed for the recapitalisation of the Greek banks and as sweeteners for bondholders. The Greek pension funds—whose lack of sustainability is a major sticking point in current negotiations—were wiped out, losing €14.5bn. New loans were also used to repay PSI holdouts, thus the Troika’s resources being used as rewards for those who did not participate.

The legal foundations for the repudiation and suspension of Greek sovereign debt have been outlined in a document—the ‘Preliminary Report of the Hellenic Parliament’s Truth Committee on Public Debt’. These are based on various types of legal arguments under international law that allow for the unilateral repudiation or suspension of debts that are unsustainable, or illegitimate, odious or illegal. A range of arguments are presented and include taking into account the behaviour and responsibility of the creditors, for example, where there is lack of good faith as necessitated by the Vienna Convention on the Law of Treaties. This includes sustained pressure on Greece to violate its human rights obligations to its population, and to circumvent its constitution in order to satisfy creditor demands. Arguments also include the primacy of human rights obligations over other obligations of the state, as there is sufficient evidence that Greece cannot satisfactorily uphold its human rights obligations under the debt repayment burden.

So long as current negotiations are based on the premise that Greece has the ability and will to repay there will be no happy conclusion. The IMF’s deviation, from May 2010, from its exceptional access criteria in order to formally agree to the Greek programme indicated that the Greek programme is politically orientated, a fact verified from any rigorous study of the IMF’s previous DSAs on Greece. It was a programme not designed to lead to Greek debt sustainability, but rather prevent international system risk spill-overs.

Interviewed by Julian Sayarer.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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