Italian bond yields gapped out last week after La Lega topped the country’s polls for the European Parliament, as investors worry that the party, led by deputy prime minister Matteo Salvini, may act to increase the country’s budget deficit and that Italy may eventually need to restructure its debt.
If the latter proved to be necessary, the country would have considerable room for manoeuvre at least from a legal standpoint and could act unilaterally to change the terms of its debt, according to one of the lawyers behind Greece’s debt restructuring.
“Italy has a strong array of weapons it could potentially use [to restructure its debt],” said Mitu Gulati, a law professor at Duke University in the US.
This is primarily because 98% of country’s bonds by value were issued under domestic law.
In 2012, Greece was able to insert a retroactive clause into its domestic law bonds to allow one vote by bondholders across all those issues to approve a restructuring of those instruments. That saw 96% of the €206bn eligible bonds exchanged for bonds with 46% of the original face value.
Since the beginning of 2013 eurozone countries have been required under European treaties to insert similar collective action clauses into their new issues to prevent holdout creditors from escaping haircuts in the future.
However, Gulati and a colleague Mark Weidemaier, law professor at the University of North Carolina, believe that because nearly all of its bonds come under domestic law, Italy is in an even stronger position to effectively dictate terms to bondholders, without facing legal challenges.
Research by Gulati’s law faculty has discovered that Italy’s domestic debt is issued under a 2003 decree.
This does not allow bond investors to accelerate payments in the event of skipped coupons or other changes. It also means that any who object to changes to terms would have difficulties in challenging decisions in the Italian courts.
The 2003 decree also allows Italy to “transform the maturities” of its bonds. That would allow it to reprofile its domestic debt should refinancing become too expensive. In the event of a sovereign crisis, that might be attractive to the country’s banks, as they would not have to take a haircut on such a reprofiling.
REDENOMINATION
Gulati said Italy would not even have to ask its bondholders to back any plans it might have to redenominate its debts into a new currency should it wish to leave the euro, or set up a parallel currency.
“Investors would not be encouraged to own Italian bonds with a view to holding out as a strategy against any such measures,” said Gulati.
STAND-OFF
Although the yield on Italian 10-year bonds is now 300bp wider than their German equivalents, which are currently negative yielding, most in the market think the stand-off could worsen ahead of Italy’s budget, due in September.
Jim Reid, a strategist at Deutsche Bank, said in a note: “The more interesting item to watch will be Italy’s 2020 budget, due by end of September, which could include fiscally costly items like the flat tax and no VAT, which is more likely to spark a substantive confrontation with the [European] Commission.”
On Wednesday, the Commission wrote to Italian finance minister Giovanni Tria formally asking how Italy intended to reduce its debt of more than €2trn from its current ratio of over 130% of GDP, the highest in the eurozone after Greece. The EC could fine Italy up to 0.5% of its GDP or €8.7bn.
“The current EC-Italy clash is only the ‘aperitivo’ before the autumn discussion,” said Nicola Nobile, an economist at Oxford Economics.
