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ECB Greek Plan May Hurt Bondholders While Triggering Debt Swaps

The Greek National Flag Flies
A plan being considered by the European Central Bank to shield its Greek bond holdings from a restructuring may hurt the euro because it implies senior status for the ECB over other investors, UBS AG said. Photographer: Simon Dawson/Bloomberg

The European Central Bank’s plan to shield its Greek bond holdings from a restructuring may hurt private investors while paving the way for debt insurance contracts to be triggered.

The ECB will exchange its Greek debt for new bonds with an identical structure and nominal value, though they’ll be exempt from so-called collective action clauses the government is reportedly planning. That implies senior status for the ECB over other investors, according to UBS AG, and the use of CACs may lead to credit-default swaps protecting $3.2 billion of Greek bonds being tripped.

“It may appear that the ECB is receiving preferential treatment, raising questions about whether the ECB is senior to private-sector bondholders,” according to Chris Walker, a foreign exchange strategist at UBS, the world’s third-biggest currency trader. “If a coercive default does indeed eventually take place then a CDS event seems very likely with all the negative consequences for risk appetite that may bring.”

Government officials are separately negotiating a writedown of the nation’s debts with private investors before a 14.5 billion-euro ($19 billion) note comes due on March 20 that risks sending Greece into default. The yield on the nation’s benchmark 10-year bond jumped 28 basis points today to 33.67 percent as of 1:30 p.m. in London, its sixth straight day of increases.


Subordination of other bondholders behind the central bank is a problem “not only in the case of Greek debt, but also regarding the debt of other euro-zone nations that the ECB may be purchasing,” London-based Walker wrote in a report. The ECB’s plan “will likely lead to euro weakness,” he wrote. Still, it’s “a sign of progress toward an eventual Greek debt restructuring.”

UBS estimates the euro will slide to $1.25 in three months and $1.15 in one year. The shared currency strengthened 0.4 percent to $1.3187 today.

The 17-nation currency slid 4 percent during the past three months as Europe’s debt crisis intensified, the biggest drop after the yen among 10 developed market currencies tracked by Bloomberg Correlation-Weighted Indexes. The yen fell 5 percent and the dollar declined 2 percent.

Credit-default swaps are contracts that pay the buyer face value in exchange for underlying securities or the cash equivalent should a bond issuer fail to adhere to its debt agreements.

CACs Legislation

Greece will introduce legislation next week that may allow CACs that force bondholders to accept debt writedowns, Naftemporiki reported. Swaps on Greece may be trigged if the CACs are used because all investors would be bound by a majority agreement to accept a proposed debt restructuring.

“One of the basic principles of bond markets is you cannot impose subordination on a particular set of bondholders,” said Padhraic Garvey, the head of developed-market debt at ING Groep NV in Amsterdam. “The probability of triggering CDS has increased because the ECB has protected itself.”

ECB officials previously rejected the possibility of a credit event triggering swaps, arguing it would encourage traders to bet against indebted nations and worsen the crisis.

The introduction of the clauses doesn’t in itself trigger default swaps, though using them does, according to rules of the International Swaps & Derivatives Association. David Geen, ISDA’s general counsel, declined further comment.

Credit Event

Credit events that trigger swaps can be caused by a reduction in principal or interest, postponement or deferral of payments, or a change in the ranking or currency of obligations. Any of these must result from a deterioration in creditworthiness, apply to multiple investors and be binding on all holders. ISDA’s determinations committee rules whether contracts can be tripped.

Default swaps insuring $10 million of Greek debt for five years cost $6.8 million in advance and $100,000 annually, according to CMA. That implies an 89 percent chance the government will default in that time.

A total of 4,183 contracts insuring a net $3.2 billion of Greek debt were outstanding as of Feb. 10, according to the Depository Trust & Clearing Corp., which runs a central registry for the market.

“If indeed this maneuver is intended to protect the ECB from forced losses, then the risk of a voluntary restructuring morphing into a coercive one has arguably increased significantly,” UBS’s Walker wrote. “A private-sector bondholder that has been suddenly and unexpectedly subordinated may have a reduced incentive to continue to hold onto that debt.”

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