Greek adviser backs senior crisis bonds as Italian solution

5 min read
Christopher Spink

Italy should issue a new type of bond that is senior to its outstanding instruments if it needs emergency funds to weather the coronavirus crisis, according to Lee Buchheit, the sovereign debt restructuring lawyer who has advised Greece, Argentina and others.

Italy is one of the most heavily indebted countries when comparing its outstanding government bonds to GDP, which was around 135% before the current crisis. Experts are worried that with Italy’s economy virtually shut down, its debts are unsustainable.

That has provoked a debate about whether Italy could follow Greece and other eurozone members that eight years ago sought assistance from other members of the currency bloc via the European Stability Mechanism.

Such a bailout is seen as impractical given the size of Italy’s debt, with €250bn maturing this year. Alternatively a group of finance ministers of southern eurozone states, including France, Spain and Italy, have called for the bloc to issue euro or coronabonds collectively to fill fiscal gaps.

Germany and the Netherlands have resisted such proposals. Instead some suggested mutual bodies such as the European Investment Bank could be the issuing entity. A Eurogroup conference call is being held on Tuesday to discuss the situation.

“There are no easy answers,” said Ugo Panizza, professor of international economics at the Graduate Institute, Geneva. “Will there still be a GDP in Italy by the end of the year? If it is down by 10% then the debt still goes crazy. There may either be a massive exercise of European solidarity, some sort of mutualisation - or it may be time to call the lawyers."

Buchheit said that eurozone countries themselves should issue emergency bonds that are deemed senior to outstanding instruments to ensure take-up.

“Let’s call them 'senior coronabonds',” he said. Because Italy and most other major members of the eurozone issue bonds governed by their own law it would be legally possible to do this.

“The change would involve giving senior coronabonds a statutory seniority — in effect, a first claim on the public exchequer — over other sovereign obligations governed by the country’s own law,” he said.

The move would echo the tool Buchheit advised Greece to employ when restructuring its €206bn debt in 2012. Most was written under Greek law, allowing parliament to vote through a clause imposing a change of terms on the debt retroactively.

One problem may be that the European Central Bank, via the Bank of Italy, is already a major owner of Italian government bonds. It might resist being subordinated, as the ECB did in 2012 when it refused to include its Greek holdings in any restructuring.

Buchheit said official sector holders of Italian obligations should first be asked to voluntarily agree to subordination and pledge not to receive payment if the senior coronabonds were in default, and pass on any money they received to senior coronabond holders.

“This subordination would not involve a forgiveness of claims by the official sector institutions, only an acknowledgment that senior coronabonds are entitled to priority payment,” said Buchheit.

Buchheit said this idea will only work if it was made clear that the senior notes were issued simply to cover a funding gap for a limited period.

“Senior coronabond issuance for any particular country must be kept to a tightly prescribed, manageable aggregate size,” he said. “Legal subordination is effective only if it is implemented on a targeted, transparent basis.”

Receiving emergency funding from the ESM is akin to taking on senior debt in any case, he said, since the ESM, like the International Monetary Fund, claims “preferred creditor” status and must be paid before other debts.

“The difference is that European taxpayers ultimately stand behind an ESM loan. Only the debtor country’s credit is on the line for a senior coronabond,” he said.

This would get around the objections of some eurozone members from explicitly being seen to use taxpayers’ money to fund another country, as long as all agreed that debt held by the ECB was temporarily subordinated.

Others have argued that the ECB’s €750bn pandemic emergency purchase programme is so extensive that it would allow it to step in and keep funding any eurozone country in distress.

"ECB purchases of government bonds in 2020 will be huge, and probably will be able to absorb all the new debt issuance for 2020. This can keep Italy’s cost of funding contained," Citigroup said in a note.

Alain Durre, economist at Goldman Sachs, said more ambitious solutions, such as coronabonds, remained some way off because of the political differences between eurozone members, indicating a compromise is likely.