Greek Bond Swap 101

Tomorrow, at 8:00 pm GMT, we’ll finally be treated to one of the most-awaited events this week – the Greek bond swap announcement. If you remember, I mentioned it early on this week when I talked about the two possible market themes that could overshadow the upcoming non-farm payrolls.

Judging from how currencies have been moving recently, I think it’s pretty clear that traders and investors are very worried about the turnout of the deal. The VIX index, which is also called the fear index, has been soaring ahead of the announcement. As a result, both the safe haven U.S. dollar and the low-yielding yen have been making significant advances across the board.

Greek Bond Swap 101

The bond swap deal is basically Greece’s way to avoid default. The deal allows private investors to exchange the Greek bonds they are holding for new ones. The new ones would have a much later maturity date and also have lower returns.

But for the deal to be sealed, majority of bondholders must first agree to the swap voluntarily. To entice bondholders to take the deal, Greece has offered payments up front and added interest payments connected to the development of Greece’s economy.

The parties who accept the deal are expected to lose a little over 53.5% of the nominal value (70% if net present value is used) of bonds that they exchange. The Bank of International Settlements (BIS) estimates that approximately 25.8 billion EUR will be lost if ALL bondholders took up the swap deal. On the other side of the coin, the deal would enable Greek government to write down about 100 billion EUR of its debt.

The actual swap is scheduled on March 12, but the settlement date for those who hold Greek bonds issued under foreign law has been tentatively exactly a month after that

What’s the latest scoop on the Greek bond swap deal?

The Good

Economic gurus predict that 75%-80% of investors will agree to exchange their bonds.

Greece’s Finance Ministry also announced yesterday that six of the country’s largest banks have agreed to participate. A government official cited them as the National Bank, Eurobank, Alpha Bank, Piraeus Bank, ATE Bank, and Postbank.

The Bad

On the not-so-bright side of things, the Finance Ministry made it clear to everyone that it is ready to activate CACs of Greek bonds if needed. CACs, or collective-action clauses, are provisions in the Greek law that would make ALL bondholders (yes, even those who are against it) to exchange their bonds if the majority agrees.

The problem is, when CACs get triggered, it could already be considered a credit event. Heck! Renowned credit rating agency S&P has already downgraded the country’s credit rating to selective default from CC after Greece had mentioned adding CACs to the debt deal re-negotiation.

There were also talks that despite Greek Finance Minister Evangelos Venizelos’ efforts to convince investors that the debt swap is necessary, four Greek pension funds said that they would refuse the deal. Yikes!

So what can we expect after announcement is made tomorrow?

If the number of investors who would agree falls below 66%, Greece would default on its debt obligations and we’ll see the euro get sold-off aggressively. Equity markets would probably also see massive drops as panic strikes Europe and policymakers scramble for damage control.

Basically, a participation rate below 90% would put Greece at risk of triggering CACs. Sadly, no one is expecting to see that many investors agreeing to the government’s terms.

The best that Greece could hope for is for the participation rate to fall somewhere between 75% and 85% as this would still put the decision of triggering CACs into debate. However, if it’s somewhere between 66% and 75%, CACs are a done deal.

Regardless, Greece’s fate would then fall to International Swaps and Derivatives Association (ISDA), the committee which would decide if the lack of investor participation in the debt swap constitutes a credit event.

If ISDA says yes and Greece has to default on its debt, the best thing to do is to keep tabs on the bond yields of other European countries. If the yields skyrocket, then you must brace yourselves. A contagion could already be unfolding right before your very eyes.

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