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Bond dealers sceptical about eurozone plans

By David Oakley
Published: March 29 2011 20:00 | Last updated: March 29 2011 20:00
It will not happen for more than two years. But moves to create an orderly process for eurozone sovereign defaults are already threatening a total shutdown of the peripheral bond markets.
The agreement to create a legal route to default from 2013 at last week’s European Union summit has sent Greek, Irish and Portuguese yields sharply higher and reduced what little volumes there were in these markets to a trickle
The reforms, which will force private investors to sharetheburdenofdefaults, also prompted Standard & Poor’s on Tuesday to cut long-term credit ratings of Greece and Portugal.
Of all the decisions approved by the EU in last Friday’s so-called “grand bargain” to tackle the debt crisis, investors and strategists say it is one of the most important because it has significant ramifications for the eurozone’s troubled periphery.
Gary Jenkins, head of fixed income at Evolution Securities, says: “This could kill the peripheral eurozone bond markets stone dead. There are very few buyers of these bonds but this could be the final straw.”
All eurozone government bonds from July 2013 will have collective action clauses, or Cacs, written into them, which will outline a framework for default and give a majority of creditors, probably about 70 per cent, the chance to trigger a restructuring.
Alongside this, a permanent rescue fund – the European Stability Mechanism – will be created, which troubled countries can draw upon for emergency loans.
Critically, the ESM will have senior creditor status over fund managers, meaning private investors will be last in the queue for the recovery of money.
Although these decisions were first announced in October last year, the final agreement last week has made peripheral bonds even less appealing to investors by focusing their minds more intently on defaults.
Delays to beefing up the temporary rescue fund, the European financial stability facility, and arguments over how much capital should be set aside for its successor may prove to be bigger headaches, but Cacs are already influencing investment decisions.
Many fund managers are refusing to buy existing peripheral bonds, even though they do not have Cacs written into them – they think these bonds may suffer similar haircuts to those issued after 2013.
M&G Investments has warned that it will not buy peripheral bonds while AllianceBernstein insists it will only buy them in return for higher yields.
Yet Cacs have worked well in emerging markets since they were first introduced by Mexico in 2003 after the default of Argentina two years previously.
The Argentine default convinced policymakers that the restructuring process needed clarifying. They are now common in most emerging markets in Latin America, Asia and central and eastern Europe.
Mexico, Brazil, Indonesia, South Korea, Poland and the Czech Republic issue bonds with Cacs to reassure investors.
Nigel Rendell, senior emerging market strategist at RBC Capital Markets, says: “I think the general consensus in emerging markets is that collective action clauses are a good thing.”
This is because they tend to reduce yields as they offer creditors a collective force and prevent a small minority of so-called hold-outs blocking a default.
That, then, speeds up restructuring negotiations and provides a market solution to a problem that could, like Argentina, otherwise drag on for years.
But in the eurozone, it is a different story.
That is because last week’s agreed framework for a restructuring has once and for all dispensed with the pledge by policymakers – made at the outset of the debt crisis – that a default would be avoided at all costs.

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