Vultures prepare for Greek battle

Greece looks set to face a protracted legal battle with so-called “vulture funds” over large chunks of its foreign-law-governed bonds, regardless of the outcome of the ongoing negotiations to restructure its debt.

Distressed debt funds began targeting Greek foreign-law bonds last year with an eye to building up a sufficiently large stake to hold out against, and ultimately profit from, a Greek restructuring. Funds such as Elliott Associates have deployed this tactic successfully in past sovereign restructurings, including those of Argentina and Peru.

The total amount of Greek foreign-law debt is fairly sizeable at €18.5bn, or just under 10% of the €200bn of Greek bonds that are subject to restructuring through the so-called private sector involvement (PSI) programme. Traders now believe that distressed funds have managed to build up blocking stakes in some of these bonds.

Market participants expect Greece to decline to pay out on these bonds if hold-outs manage to block a restructuring by building up more than 25% in a particular issue. At the same time, funds are preparing other legal arguments to recover their investments, which could take years for courts to resolve.

“We’ve heard that these funds have big enough stakes in some foreign-law bonds [to block a restructuring] – I know some people at small funds and some correlation desks that hold these positions,” said the trader in charge of distressed sovereigns at a major bank.

“If there is only one bond that is blocked, Greece will probably pay it out, as it’s not a big deal and they don’t want to set a precedent. But the likeliest outcome is that it’ll be more than one bond. I believe there’ll be a failure to pay on [the foreign-law] bonds because Greece is bust and no one wants to pay these free-riding hedge funds,” he added.

Much uncertainty continues to surround the outcome of the Greek debt restructuring. Provided it goes ahead, collective action clauses (CACs) are likely to be inserted into Greek bonds. If a majority – normally either 66% or 75% of holders of a particular bond by value – then agrees to the restructuring, the CAC will bind all holders of that bond to the restructuring.

“We never see any offers on English-law debt, even though there is a fairly active market in GGBs more generally. I definitely think they have enough of a blocking stake”

Foreign-law bonds were targeted by vulture funds as they are mainly subject to English law, and investors therefore feel they would have a better chance of reclaiming their investment. These bonds have consequently traded at a premium to domestic-law bonds.

For example, a SFr650m 2.125% bond maturing July 2013 has risen by 15% over the past month to 40.6% of its par value, whereas many Greek-law bonds are now trading at between 20% and 30% of par.

Given the opacity of secondary bond markets, it is impossible to know whether vulture funds have built up a sufficiently big stake in certain bonds to block their restructuring. However, sources on market-making desks and at buyside firms believe that the vulture funds have been successful.

“We never see any offers on English-law debt, even though there is a fairly active market in GGBs more generally. I definitely think they have enough of a blocking stake,” said one hedge fund manager who trades sovereign debt. 

Prolonged legal battle

If Greece opts not to pay the foreign-law bonds, it could face a prolonged legal battle. If the ECB participates in the bond exchange, as is now expected, this might eliminate a potential line of argument for distressed investors: preferential treatment for the central bank to the detriment of other creditors.

However, Steven Friel, a litigator with law firm Brown Rudnick, which specialises in representing funds in these types of cases and is actively following the Greek situation, noted that there were a number of other options available to holders of foreign-law bonds, should Greece default.

The most obvious route would involve bondholders suing in the English courts, similar to the cases being brought by holders of Irish bank debt following the restructuring there last year. They could also bring an action in the Greek courts on constitutional grounds. Another option would be to claim that the default breaches the European Convention on Human Rights, for effectively confiscating the funds’ property.

Finally, Friel said investors might take action against Greece in an international arbitration tribunal under the auspices of one of the 38 bilateral investment treaties that Greece has entered into with other states, including Germany, for expropriation of their investments by the Greek government. A group of Italian investors are still pursuing this path against Argentina, despite it defaulting on its debt more than a decade ago.

“I would be very surprised if any investor has bought up these bonds without having thought through a strategy of how it is going to recover on its investment,” added Friel, who declined to comment on particular clients.