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A Primer on the Great Greek Bond Swap

Wednesday, 7 Mar 2012 | 8:13 PM ET
Aris Messinis | AFP | Getty Images

Thursday is the deadline for private sector holders of Greek government bonds to decide whether to accept a proposed restructuring.

Restructuring the private sector’s bonds to reduce the country’s debt burden, which is known as private sector involvement or PSI, is the last hurdle Greece faces in order to be eligible for a €130 billion bailout from the European Union and International Monetary Fund.

Greece needs holders representing at least fifty percent of the bonds to agree to tender their bonds in exchange for new bonds worth far less. Under a new Greek law, the Greek government could then begin the process of invoking the “collective action clause” that has the power to automatically convert most of the remaining bonds.

In order to invoke the collective action clause, two-thirds of the bondholders would have to agree to the mandatory conversion. Bondholders who agree to swap their bonds tomorrow will be presumed to have voted in favor of invoking the collective action clause. Bondholders who don’t swap Thursday will have the choice to vote yes or no on the question.

This is why Greece is unofficially aiming to have two-thirds of the bondholders agree to the swap on Thursday—it will guarantee that the collective action clause can be invoked.

The collective action clause would impose a mandatory swap on the 86 percent of the Greek government debt issued under Greek law. The remaining foreign law bonds cannot be automatically converted.

Assuming Greece gets the sought after PSI, European Union finance ministers are expected to agree to release the final bailout funds after a conference call Friday.

If the PSI falls short, however, Greece would likely not receive the bailout funds. Without those funds, it will default on a bond payment due within weeks.

The Institute of International Finance, which has been representing private sector creditors in negotiations with the Greek government, announced Wednesday that more than 30 institutions would be participate in the restructuring. These institutions—mostly banks and insurance companies, hold €84 billion worth of Greek bonds. This means that Greece can count on 40.8 percent of the bonds tendering tomorrow.

In order to encourage more participation in the swap, Greece's Public Debt Management Agency has threatened that bondholders who do not participate in the restructuring could face even less favorable terms.

Invoking the collective action clause would likely trigger a credit event under the credit default swaps on the Greek bonds. Bond holders protected credit default swaps could decide that their payouts would be higher if a credit event is triggers, creating an incentive to hold out against the tender.

If successful, the debt swap would reduce Greece’s debt load by €107 billion from Greece's total debt, plus an estimated €150 billion in refinancing costs.

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