BUYING BACK GREEK DEBT REWARDED HEDGE FUNDS
LONDON — Last month, the European Commission’s top
economic official in Brussels, Olli Rehn, received an intriguing e-mail. Greece,
under pressure from its European creditors, wanted to retire some of its debt
by buying back its bonds at a deep discount to their face value. A senior
executive at Deutsche Bank proposed that Europe take a tough negotiating stance
toward private hedge funds that had bought Greek bonds. He urged officials to
use a legal mechanism that would force the funds to sell at a lower price than
they might voluntarily accept. The move was “perfectly legal” and would not
“upset the markets,” the executive, Hakan Wohlin, argued. And by forcing
private investors to sell low — for 28 to 30 cents on the euro, instead of the
34 to 35 cents many hedge funds were aiming for — Greece could achieve
significant debt reduction at a reasonable cost. But in this latest showdown
with private investors over Greece’s debt, Europe blinked first. With litigious
hedge funds and global finance’s most powerful lobbying group warning of a
market crisis, European officials rejected the hard-line approach. When the
results were tallied on Dec. 12, Greece had reached its target of buying back
enough bonds at a discount to retire 21 billion euros, or about $27 billion, of
its debt. The bigger winners, though, were hedge funds, which pocketed higher
profits than many had expected, in yet another Greek bailout financed by
European taxpayers. To some experts, this latest chapter in the long-running
Greek drama is another reminder of how private investors have outmaneuvered
European officials at various stages of the debt crisis. And they caution that
each time it happens, future debt workouts in the euro zone will become even
more costly. “I just don’t understand why they did this,” said Mitu Gulati, a
sovereign debt specialist at Duke University School of Law, who argues that
Europe could have saved up to 2 billion euros. “This would have been an easy
transaction to do, and still the hedge funds would have come out with a hefty profit.”
Opportunistic hedge funds have profited handsomely from the euro zone crisis,
be it by speculating in Greek bonds or by buying up the senior debt of failed
Spanish banks. They have successfully bet that Europe, ever fearful of
Greek-style contagion, will prefer taxpayer-financed bailouts to forcing concessions
from the private sector. In Greece this year, so-called vulture funds like Dart
Management were paid back in full after refusing to take the losses that most
other private bondholders grudgingly accepted as part of the 100 billion euro
Greek bailout that Athens and Europe agreed to in March.
The big winners this time, according to bankers and
investors, were American and European hedge funds like Greylock Capital, Fir
Tree, Brevan Howard and Third Point, all of which snapped up Greek debt last
summer as warnings grew that Greece might leave the euro and default on its
debt. Many have booked gains of 100 percent or higher.
They largely have the financial lobby to thank — in
particular the Institute of International Finance, which is based in Washington
and represents the interests of more than 450 banks, hedge funds and other
financial institutions around the world. The institute played on fears in
Brussels, Rome and Madrid that a hard-line approach to the hedge funds would
create another round of market chaos.
The warning was blunt: If Athens set off legal
mechanisms in the bond contracts known as collective action clauses, forcing
bondholders to accept lower prices, investors would stop buying the bonds of
struggling European countries. That would be bad news for Spain and Italy — to
say nothing of Portugal and Ireland when they return to global bond markets in
2013.
Countering this pro-hedge-fund argument was a small
circle of bankers, lawyers and policy advocates, the most prominent of whom was
Mr. Wohlin, the Deutsche Bank executive who sent the e-mail. Another was Adam
Lerrick, a former investment banker now affiliated with the American Enterprise
Institute.
They argued that collective action clauses have a
legitimate function: to help near-bankrupt countries reach debt restructuring
agreements with a majority of their bondholders, with a minimum of legal fuss
from investors holding out for a better deal. All euro zone countries that
issue debt next year will have such clauses in their bond contracts, and
proponents say there is scant evidence that they cause market turmoil.
“If you use these features within the rules, they
should not cause any disruption,” said Jeromin Zettelmeyer, a sovereign debt
specialist at the European Bank for Reconstruction and Development.
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Mr. Wohlin, who was the lead financial adviser to
Greece in the buyback, said he was not authorized to discuss communications
with clients. That includes his e-mail to Mr. Rehn, the European Commission’s
senior economic official, parts of which were reviewed by The New York Times.
He said that while he strongly believed that using
collective action clauses in a buyback could achieve maximum debt reduction,
such an effort would have required a financial commitment that Europe was not
willing to make.
“The price Greece paid was a very fair one,” Mr.
Wohlin said. “And kudos should go to the official sector, which executed a deal
that was fair for the taxpayer and did not upset the market.”
For collective action clauses to kick in, two-thirds
of investors must agree to the offer price, and European officials say there
was no certainty that this would have happened. A buyback was only going to
work if enough investors holding Greek bonds could be persuaded to sell — and
in the early summer, when it looked as if a Greek default and departure from
the euro zone might be imminent, that prospect seemed ludicrous.
But when Greek bonds trading on the open market hit a
low of 12 to 13 cents on the euro over the summer, some investors started to
ignore the doomsaying on Greece and scoop up the country’s debt on the cheap.
Among those investors was one of Citigroup’s in-house
hedge funds, which piled into Greece even as the bank’s lead economist, Willem
H. Buiter, was estimating a 90 percent probability of Greece leaving the euro.
By the fall, Greek bonds had become one of Europe’s
most popular high-risk bets. But as demand sent the price soaring to 25 cents
on the euro, some money managers began to worry about how they might leave
their positions.
At the same time, it was becoming clear to Greece’s
official European creditors that the country would miss debt-reduction targets
set in its March bailout program. A quick solution was needed.
But there was a problem. Seventy-five percent of
Greece’s debt was now owed to European governments, the International Monetary
Fund and the European Central Bank — none of which would accept a loss.
So attention turned to the 62 billion euros of debt
held by the private sector.
The conditions for a buyback seemed propitious: the
debt was trading at a 75 percent discount, there was a pool of holders ready to
sell and, most crucially, the bonds were blessed with collective action clauses
expertly tailored by Lee C. Buchheit of Cleary Gottlieb, the foremost legal
authority on how to reel recalcitrant bond investors into a restructuring deal.
In the face of stiff opposition, Germany embraced the
concept. In his e-mail to Mr. Rehn, Mr. Wohlin of Deutsche Bank argued that
there was nothing to fear in using collective action clauses.
On the contrary, he wrote, such clauses are used in
most debt restructuring exercises, and investors “would expect Greece to use
it.”
To some degree, Mr. Wohlin was right. As the hedge
funds’ bond stakes grew, their lawyers prepared arguments to counter the
strategy.
Also swinging into action was Charles H. Dallara, the
departing managing director of the Institute of International Finance, the
investors’ lobbying group. Mr. Dallara flew to Athens in mid-November to tell
the government that invoking the clauses would be disastrous for Greece and the
euro zone. He also made calls to, as he put it, “the highest levels in Europe.”
His warnings resonated.
There would be no use of collective action clauses,
and bankers were told to fashion a voluntary plan. As word seeped out that the
exchange would be a friendly one, hedge funds pressed their advantage.
“I won’t even answer the phone for anything less than
35 cents,” one large holder said in late November.
On Dec. 3, the terms of the buyback were announced.
To the market’s pleasant surprise, instead of the
average price of 28 cents agreed to earlier, the offer was made at an average
price of around 33 cents.
One week later, the deal was done.
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