Thursday, 20 September 2018

The "Selective Default" Debate: Caveat Creditor

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What is the difference between developing a flexible approach to dealing with a crisis and simply making up the rules as one goes along? Not a lot, so far as I can tell. The recent spat between S&P and all comers with respect to whether or whether not Greece will be in “selective default” if the banks roll over their Greek loans – pursuant to the French model – is over just this.

There is no doubt that in order to avoid a formal default by the Hellenic Republic, all parties will need to don the same rose-tinted spectacles and firmly look the wrong way. Briefly disregarding the point as to whether it would be an advantage to the Greek people to default and to get the debt monkey off its back, the debate is now getting technical and rather indecorous.

S&P tells us it might declare a default. The ECB strikes back by stating that despite its rule that it will not accept paper of a defaulting nation as collateral, it has now decided that it will accept the highest of the three main ratings agencies’ findings. In other words, until all three (Moody’s, S&P and Fitch) have declared a default, it will continue to take Greek paper.

This flies in the face of absolutely every basic principle of lending in markets where best practice and prudence dictate that one is to apply the lowest rating to investment decisions. If these are the standards which the central bank of Europe intends to apply, what chance for the rest of us?

At the same time, European authorities of all hues are opining as to whether the “re-profiling” will constitute a credit event under ISDA rules. Unless I am very much mistaken, the only authority which can decide on this is and remains ISDA itself and to see Brussels and Frankfurt trying to arbitrage the rules leaves me with a very nasty taste. Having spent a chunk of my banking career working in a division which lived to make something which was not triple A into something triple A rated, I am now watching people trying to make something which is D into something which isn’t D rated. Spot the difference? I don’t either.

Whether or not you are a fan of the ratings agencies and their methodologies, they are a pillar of our business, just in the same way as yield-to-maturity, which cannot be calculated for anything other than zero coupon bonds and which is not even a worst-guess estimate but which we still calculate to four decimals… or price-earnings ratios where we don’t know the earnings.


I’d also like to know how both the agencies and the authorities will deal with cross default. Of course we will all be cross if Greece defaults but I struggle with the concept of selective default. Unless I am mistaken, the bond markets are structured with both negative-pledge and cross-default clauses. Are these now to be suspended too?

Looking beyond the Greek situation, and adding in the bailing-in threats, mandatory haircuts and the likes, if lenders are to be faced with documentation which is only valid until someone declares that it isn’t any more, then we will be creating a world in which beyond the three classical risks, namely credit risk, transfer risk and political risk we will need to price a fourth risk, namely documentary risk. In pursuit of a short term solution of the Greek problem, the politicians and authorities risk opening Pandora’s Box with respect to long established global borrowing and lending conventions – caveat creditor.


Meanwhile, private equity is probably sharpening its pencils for the “Great Greek Giveaway”. The prospective privatisation programme has been likened by Jean-Claude Juncker to that of Eastern Germany after re-unification where 14,000 companies were sold by the Treuhand in just four years. This all will look to the Greeks like the bailiffs turning up at the door, walking off with their best Persian carpet and then flogging it at any knockdown price in order to cover an unpaid parking fine. This is all very unseemly and, as I suggested a while back, who would want to buy a Greek national asset if the workforce, notoriously fickle even at the best of times, isn’t in a mood play ball? Risk pricing might look as though it’s all done and dusted. I beg to differ. We have seen any number of asset rallies launched by putative solutions to Greece come and go again. Fade the rally; it can’t be wrong.

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