While the general market mood is one of pre-default euphoria reminiscent of that in the pre-Lehman weekend, clouds may be brewing. As Reuters reports, "Some hedge funds have found a legal loophole they believe will force Greece to repay some of its debt in full, three sources close to the matter said on Thursday, in a move that would intensify the standoff between the country and its debtors." The loophole? A tiny €412.5 million bond issued by Hellenic Railways with a clause that "allows bondholders to argue that Greece is in default if it is trying to restructure or change the terms of its debt, the sources said. The creditors could already argue that Athens has defaulted, and if they buy up a quarter of that bond -- or enough of it not to be forced into the debt swap -- they can also then demand immediate repayment, a process known as acceleration." More: "The funds are now trying to buy up enough of the bond -- issued by state-owned Hellenic Railways and guaranteed by the government -- to force Greece to repay them in full, to the tune of some 400 million euros. If Greece refuses to do so, this may trigger similar provisions on other Greek railway bonds, potentially landing Athens with a bill of about 3 billion euros, with investors demanding immediate repayment, the sources said." Things could move very fast since the PSI results are due in 7 hours: "Sources close to Greece's negotiation fear the funds could already start the acceleration process by Friday, or next week, if they find they have a big enough majority."
And while the amount is nominal, once legislation has commenced that does in fact find Greece in default it could well derail the PSI process even retroactively as this outcome could be seen as a Matrial Adverse Change in the conditions for the PSI, as a par payout will certainly infuriate others who are not only getting crammed down on the current bonds, but have a 85% discount to look forward to on the "fresh start" bonds as well.
And finally, this is nothing new - the very same outcome will happen when Greece tries the UK-law bond exchange offer in a few weeks, which it will fail. Where Greece will get the up to €30 billion in cash to fund par payouts on that, and other foreign law bonds, is unclear - Greece has already said there will be no cash for holdouts under any CUSIP. And Europe will certainly not pay for the incremental cost of providing some evil, evil, hold out hedge funds with a par return, merely because they were not lazy and read the bond indenture cover to cover.
Naturally, one has to downplay this event:
It is unlikely the hedge funds could derail the overall debt swap, which will shave more than 100 billion euros off Greece's debt pile, a crucial precondition for receiving more international aid and staying in the euro.
The exchange has already been accepted by more than 75 percent of investors, a senior official told Reuters ahead of Thursday's 2000 GMT deadline.
The hedge funds have been targeting some of Greece's more investor-friendly foreign law bonds -- like the railway bond -- hoping to stop Athens from activating so-called Collective Action Clauses (CACs), used to impose losses on all holders.
This could then allow them to squeeze a bigger payout, potentially through lengthy court challenges, while creditors that do sign up to the bond swap face losses of 74 percent on their investments.
It doesn't stop with this particular bond:
Although these clauses only concern this one bond, the action by hedge funds could trigger clauses contained in other Greek railway bonds.
And because of the provisions in other bonds governed by English law, this could eventually affect more deals, potentially affecting up to 8-9 billion euros worth of debt, one of the sources said.
Maybe one should not count out the hedge funds just yet. As a reminder, those who do engage in international sovereign debt litigation stand to generate massive return if successful. Which at the end of the day is all that matters to the LPs.
