EMTA Presents Panel on Greece
On March 30, 2012, EMTA hosted a panel discussion “Greece and the Rule of Law”. This Seminar was held at EMTA’s offices at 360 Madison Avenue in NYC, and additional support was provided by Exotix Ltd.
The Greek debt exchange -- the largest sovereign bond default and restructuring in contemporary history -- came on the heels of troubling precedents set by Argentina and Ecuador in recent years that have eroded the validity of contracts, laid bare limitations in enforcement provisions, and arguably undermined the rule of law in sovereign international finance. Was Greece the product of unique circumstances or will it be considered a precedent for any subsequent sovereign debt restructurings that may take place elsewhere in Europe or beyond? This Seminar brought together experts from various perspectives who reflected on the implications and lessons learned from the case of Greece and its predecessors.
Arturo Porzecanski from American University presented a background paper, "From Buenos Aires to Athens: The Road to Perdition", and moderated the panel and subsequent discussion.
Other panelists and their topics included:
Diego Ferro (Greylock Capital Management) – Greece’s Unique Restructuring: The Dawn of a New Era?
Anna Gelpern (American University Washington College of Law and Georgetown Law) – Sovereign Debt circa 2012: Going to Pot or Going in Circles?
Larry Goodman (Center for Financial Stability) – The Perils of Precedent: Threat to the Sovereign Bond Market
Robert Shapiro (Sonecon and American Task Force Argentina) – The Costs of Disorderly Default - Lessons from Argentina
Gabriel Sterne (Exotix Ltd.) – Greece: A Retrospective and Prospective
Mr. Porzecanski began the discussion with some background information on the three sovereign defaults in the past decade, each of which inflicted NPV losses of at least 70% on bondholders: Argentina, Ecuador and now Greece. His introductory remarks can be accessed by here, and the following is an excerpt: These defaults were driven largely by political considerations, and each entailed an erosion of international creditor rights and the rule of law. Their troubling precedents are worthy of reflection.
While there is no denying that Argentina was in very serious economic trouble when it defaulted in late 2001, the problem lies in the way the default was handled. First, a number of arbitrary measures were taken just before, and right after, the default and a subsequent devaluation that complicated, and raised the cost of, crisis resolution. Bank deposits were frozen; capital controls were imposed; the application of bankruptcy and foreclosure laws was suspended; selective price controls were enacted; contracts allowing for utility price increases in the event of currency devaluation were broken; and worst of all, dollar-denominated assets and liabilities were forcibly converted into pesos, and at different exchange rates, generally benefiting debtors to the detriment of creditors.
Second, while other sovereigns in financial trouble acted promptly to cure any default, every post-2001 administration in Buenos Aires has been uncooperative, and indeed defiant, in their approach to creditors. While real GDP and unemployment had already returned to their pre-crisis levels, government tax revenues had experienced a boom, and official international reserves had been rebuilt, the enormous debt forgiveness Argentina demanded in its 2005 exchange offer bore no relation to the country’s capacity to pay.
Since that time, many bondholders and multinational investors have flocked to courthouses or to arbitration tribunals, and have obtained judgments and awards in their favor. Argentina has also failed to cure its decade-long default on its debts to the Paris Club. Argentina’s failure to act in good faith was cited by President Obama in his decision to suspend the country from participation in the U.S. Generalized System of Preferences (GSP) program.
In late 2008, Ecuador defaulted on one-third of its public foreign debt; it was a clear case of unwillingness to pay. At no point before or after the default did the government assert that servicing the debt posed a financial hardship, its public external debt was the least burdensome it had been in over three decades, relative to government revenues or GDP, and the country’s central bank held more international reserves than it had ever accumulated before. This was an ideological and personal vendetta by President Correa, who claimed that the debt was “illegitimate” (although he never appealed to the odious-debt doctrine or any other grounds for repudiation). Instead, he allegedly bought back the two defaulting bonds in the secondary market after their price collapsed following rumors of a default. Then, about five months after defaulting, the government announced an offer to repurchase the remaining bonds through a modified Dutch auction with a base price of 30 cents on the dollar. Ecuador’s latest default and bond-market manipulations made a mockery of creditor rights and the rule of law. By taking a variety of deliberate actions to depress the value of their bonds and then repurchasing them at rock-bottom prices, the authorities in Quito became the principal beneficiary of their own default, while forcing its bondholders into a “voluntary” restructuring process.
Greece’s road to default and debt restructuring in 2012 was not at all straightforward. It was Germany’s very public hard line on Greece and its private creditors that paved the downhill road that led to the systematic destruction of investor confidence, default and vicious cycle: the more the talk about “private sector involvement,” the more the rating agencies would downgrade Greece, the faster the demand for Greek bonds would evaporate, the more deposits flowed out of Greek banks, the worse the credit crunch got, the deeper the country’s recession, the greater the fiscal contraction needed to meet targets – and the more unsustainable the debt burden looked.
And when the time came to force a restructuring, expedient solutions were adopted in an exercise where the ends justified the means, including the rewriting of local law in Greece with retroactive effect to introduce CACs and bind all local-law creditors. Since more than 97% of the outstanding bonds of Spain, Italy, Portugal and Belgium are governed by local law, these countries could also enact legislation similar to Greece’s – and pass on the cost of fiscal retrenchment to bondholders, rather than to those who actually benefited from government largesse.
Mr. Shapiro reminded the audience that there is no international law for sovereign debt defaults, and that creditors typically rely on the Paris Club, the London Club and the laws of their contracts (typically NY and UK law, although not always) to navigate the default scenarios. He posited that much was at stake for creditors during a default and the time leading up to it and, thus, keeping the stability and confidence in the present norms and arrangements was very important.
The Argentina example (the largest default in EM history) is one that demonstrates what can happen when an entire regime of expectations is threatened, when negotiation is slight or non-existent, where haircuts are higher than in past defaults, and where Argentina broke new ground by repudiating the debt of those who did not agree to the restructuring (and particularly those with non-local law governed documents), while violating various covenants. This erosion of the rule of law (as exemplified by the many non-collected judgments against Argentina and the preponderance (80%) of cases in ICSID) may be a model for Greece (as well as other EuroZone countries), thus defying international norms, slowing progress throughout the region, and leading to a likely collapse of the EuroZone and international instability.
Mr. Goodman proposed to link economics with adherence to the rule of law. He stated that sovereign debt crises are no longer reserved for EM economies, a Pareto Optimal approach to sovereign debt was key for fairness to creditors and debtors, and that precedent matters, as present debt disruptions and negotiations will vitally influence the future cost of capital, even in the US. “What happens in Athens or Buenos Aires does NOT stay in Athens or Buenos Aires.”
Sovereign debt management of the restructuring process should include monitoring the sovereign’s economic capacity to determine its ability to pay, and the enforcement of the rule of law should be employed as an underlying threat to the sovereign’s unwillingness to pay. He referred to the Economic Subcommittee (ESC) to Bank Advisory Committees during the Brady Debt restructuring era as providing a guidepost for identifying common ground for the benefit of creditors and debtors and paving the way for future growth. He delineates the successes - Brazil (1994), Chile (1988), Korea (1982 and 1997), Mexico (1990), and Poland (1994) – and the missed opportunities: Argentina (2002), Ecuador (1987, 1995 and 2008), and Greece.
With respect to economic capacity, he posited a three-pronged program, which substitutes math for rhetoric – Official Institutions (highlighting available official resources to support and ensure implementation of a successful program), Economics (restoring growth for a long-term solution through fiscal, monetary and FX policies) and Finance (identifying sustainable levels of debt and potentially needed support for banks, while mobilizing sovereign and private balance sheets).
He stated that the Center for Financial Stability (CFS) Rule of Law Index (RLI) is based on the following:- Property Rights, Burden of Government Regulation, Efficiency of Legal Framework in Settling of Disputes, Efficacy of Corporate Boards and Strength of Investor Protections. For every 25 point weakening of the RLI, sovereigns can expect a 200 basis point increase in bond yields.
He concluded with the following thoughts: sovereign debt negotiations must more readily incorporate a nation’s ability to pay; enforcement of the rule of law will reduce the need for debt restructuring and hasten fair exchanges when needed; and together these measures will facilitate capital formation and keep the cost of capital low globally.
Mr. Ferro provided some background on the Greek restructuring, one of the largest sovereign restructurings, with $200 billion restructured in about five months. He posited that the “rules of the playground” were not created by Greece and its creditors, but rather by the IMF and EU, who had much to gain from a successful deal. He also lauded the IIF in organizing the creditor group, as well as Greece who came to the table in good faith, ready to negotiate. Whether the deal was voluntary or not may be debatable, but what was clear was that Greece wanted its currency to remain the Euro and investors wanted to minimize their losses. He maintained that, while possibly unfair or against precedent, Greece’s retroactive application of CACs to its local law-governed bonds was not illegal and the restructuring was fairly successful (except for the GDP warrants, whose real value was hard to unlock, and which were callable only in limited circumstances and viewed by him as a missed opportunity to replicate the Argentina GDP example (where 20% of the haircut would likely be recovered in eight years)). The difference between local law and foreign-law governed bonds should be priced accordingly with a fairly dramatic spread.
He also briefly mentioned CDSs (the ramifications of which were the least discussed issue in the negotiations), and he cautioned the market against feeling a false sense of confidence in the CDS documentation, which, though improved, still may not adequately provide the default protection that some investors desire.
He concluded by stating that the problem with EM is a lack of rule of law, although post-2008, when the crisis is big enough, no law is sacred (not Greece’s, not the ECB’s, and not GM or Chrysler’s). Investors should look at all sovereigns with EM in mind and “shame on us” if we don’t realize that life is sometimes unfair.
Ms. Gelpern introduced her presentation with three old lessons that Greece has re-taught the market and three areas where Greece has uncovered previously under-appreciated problems that bear watching. First, domestic law creates considerable leeway for the sovereign debtor wishing to restructure and is disadvantageous to creditors, rendering them vulnerable to local law’s vicissitudes (see the US defaults and Russia’s in 1998). Greece’s domestic legislation to retrofit majority voting provisions in its debt is routinely mischaracterized as a contractual move; in her opinion, it was just a kinder, gentler statutory modification. Second, contract terms are only relevant at the margin; they do not make a sovereign restructuring happen, though they might affect recovery on some instruments and might suggest the form for a restructuring. Who holds the debt and how it is treated for regulatory purposes are more important factors. This suggests that the European exercise to include CACs in all EuroZone sovereign bonds is a distraction. Third, collective action problems among private creditors have always been and continue to be manageable. Recent literature suggests, and Greece confirms, that bondholder coordination problems are not the biggest, or even a big, obstacle to restructuring. On the other hand, if ongoing Argentina litigation comes out the wrong way, this lesson might be unlearned, and we may start another conversation about sovereign bankruptcy.
As for new lessons from the Greek restructuring, she opened with the formidable official sector coordination problems that could be an obstacle to future restructurings. Greece had no agency in the negotiation from the moment it decided to stay in the EU. Private sector involvement was a mix of financial necessity and EU political imperative. Against this background, the capacity of individual “guarantors” like Finland to hold up the restructuring and extract side payments is impressive and does not bode well for regional crisis management going forward. Separately, the role of the IMF (neither the indispensable nor the biggest source of official financing) in the restructuring process was fundamentally different.
Second, the role of central banks in sovereign debt management was tested. In one sense, the ECB’s multilateral character may make this look like a unique situation. However, it acted as a central bank, not a multilateral lender of last resort like the IMF. Its exclusion from restructuring raises major challenges for central bank policy and sovereign debt treatment going forward. There needs to be a way to protect central bank functions without locking up a substantial portion of a debt stock and insulating it from restructuring.
Third, the Statutory/Treaty Approach to sovereign debt restructuring is making a comeback. The ESM Treaty specifically refers to private sector involvement and contemplates mechanisms for sovereign debt restructuring (albeit ones that are unlikely to make a difference). This may be a move to institutionalize sovereign bankruptcy procedures, at least at a regional level (although she does not particularly favor the SDRM approach). One lesson that Argentina and Greece have in common is that one cannot take “institutional norms” in sovereign debt restructuring to the bank.
Mr. Sterne suggested the following six principles of crisis resolution: 1) Act quickly and decisively (procrastination kills), 2) Have realistic assumptions on the capacity to repay (with attendant better IMF debt sustainability analyses), 3) Observe the principles of burden sharing by avoiding dominance of special interest groups, 4) Provide upside to debtor by catalyzing reforms (and not pushing retroactive CACs like the IMF did instead of being the guardian of international law), 5) Provide upside to creditors by catalyzing new investment flows (and scrutinizing more carefully ratings), and 6) Preserve faith in financial architecture. The root of the problem, he posits, is incompatible incentives among policy constituencies dictating short-sighted policies that are behind the curve, and a collapse of trust in the financial markets that could have very lasting effects. He also touched on burden shifting arguments, CDS, stress tests and institutional moral hazard.
Arturo Porzecanski Introductory Remarks
Arturo Porzecanski: From Buenos Aires to Athens: The Road to Perdition
Lawrence Goodman: Perils of Precedent: Threat to the Sovereign Bond Market