Banks looking to strengthen hand and avoid sovereign debt restructuring

Knowing that it is a matter of time before they are forced to restructure all of their sovereign debt holdings, banks are trying to take steps to protect themselves.

According to an article in the International Financing Review, the Institute of International Finance, a leading bank lobbying group, is trying to change the terms on which sovereign debt is renegotiated.

For example, the banks would like official institutions that hold the debt, like the ECB, to also be required to incur losses.

The biggest change is the banks would like the governments to provide what would be the equivalent of ultra transparency for a government ('enhance data and policy transparency') so that the banks were not left in the dark about what is going on.

Your humble blogger is thrilled to see that banks are such big fans of ultra transparency.  Naturally, given that banks recognize the benefits of ultra transparency, banks should be leading the charge to provide ultra transparency about themselves.

I expect all 450 banks that are members of the IIF as part of their push to change the terms on which sovereign debt is renegotiated to voluntarily provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

The world’s biggest banks are drawing up tactics to strengthen their hand in future sovereign debt restructurings, as they seek to avoid another situation similar to the Greek debt talks, when government pushed them into accepting to tens of billions of euros in writedowns. 

The Institute of International Finance, which represents 450 banks around the world that collectively represent the biggest buyers of government debt, has proposed changing the documentation of future bond sales after finding many aspects of the Greek restructuring flawed.

No doubt the banks found that the restructuring was flawed.  The restructuring resulted in the banks taking losses that were not directly paid for by the taxpayers.

If banks were forced to take additional losses on sovereign debt that were not paid for by the taxpayers, this could put the bankers' cash bonuses in jeopardy.

Clearly, something has to be done to retain the sanctity of and bankers' entitlement to their bonuses.

It called for the restoration of the “Principles for Stable Capital Flows and Fair Debt Restructuring” established by the IIF following sovereign debt crises in Latin America, Eastern Europe and Asia. 

Moreover, it argued that the absence of open dialogue, transparent and good-faith negotiations, plus fair treatment of all investors, endangers the normalisation of market access and financial stability.

The most important principle underlying stable capital flows and fair debt restructuring is that the banks recognize upfront the losses that they will ultimately incur should they go through the long process of default and foreclosure on the bad debt.

In the case of Greece, the banks would write off 100% of the sovereign debt.  We are talking about a country that is in a depression with its society and economy falling apart.

The most practical measure the IIF proposes is adding aggregation clauses to documents, which would prevent minority investors – such as hedge funds – from blocking future agreements. 

“Fair treatment of all creditors is in the interest of both issuers and creditors,” the IIF said in a report. “It lessens the burden on all creditors and, by avoiding discrimination, encourages creditors to participate voluntarily in debt resolution.”

As I recall, this is not a problem for sovereign debt that is issued under the sovereign's laws (Greek debt subject to Greek laws).  It is a problem for sovereign debt that is issued under UK laws.

No matter how much the banks would like it, there is absolutely no reason that a sovereign should give up its right to change the terms on the debt issued under its own laws.

The report, written by the IIF’s Joint Committee on Strengthening the Framework for Sovereign Debt Crisis Prevention and Resolution, examined the Greek debt restructuring from the vantage point of private creditors. 

In particular, the report criticised the retroactive adoption of legislation that introduced a collective action mechanisms into Greek-law government bonds. The manoeuvre raised concerns about the sanctity of financial contracts, the report said. 

“The retroactive change in the legal framework governing sovereign debt instruments is worrisome and sets a bad precedent,” the report said....

Actually, any investor who buys a Greek-law or similar sovereign-law bond knows that the law can and will be changed to benefit the sovereign should it experience financial distress.  This was one of the risks of investing in these bonds that bankers were fully informed about prior to making an investment decision.

The group also demanded that sovereigns make a good-faith effort to negotiate with private creditors at an early stage, including providing enhanced data and policy transparency.

During the Greek PSI negotiations, private investors often felt like they were left in the dark, which limited an open, informed and productive dialogue between private creditors and the Greek authorities, the report said.

I am sure that it was not lost on regular readers that the banks would like enhanced data and policy transparency so that they did not feel like they were left in the dark.

This is the equivalent of asking the governments for ultra transparency.

Given that banks think ultra transparency is good for them, it must be equally good for every other market participants to have when it comes to assessing a bank.

As a result, the banks should take the lead and provide ultra transparency.