France could back a private sector rollover of Greek debt as part of a new EU-IMF bailout if a voluntary formula can be found to avoid wider damage in euro zone markets, sources familiar with government thinking said.
Euro zone governments have edged closer to a compromise this week on a second Greek rescue program, with increased official funding, under which private creditors would be asked to swap their sovereign debt for longer-dated bonds.
President Nicolas Sarkozy softened Paris' previous total opposition to any form of debt restructuring, saying after the G8 summit in Deauville on May 27 that seeking ways for private investors to share the burden was different from restructuring.
French sources said he wanted to help German Chancellor Angela Merkel, who needs to assuage public anger over signing another cheque for Greece by demonstrating that the private sector is sharing the risk.
But France, Berlin's closest partner in EU leadership, reacted coolly to German Finance Minister Wolfgang Schaeuble's proposal of a Greek debt swap to extend maturities by 7 years and call for a substantial contribution from creditors.
The French line has always been to refuse the restructuring of Greece's debt ... regardless of what terms are proposed, Budget Minister Francois Baroin said on Wednesday.
Sources in both the private and public sectors said Paris was trying to moderate Berlin's tougher line on private sector involvement ahead of a summit of European Union leaders on June 23-24 which is expected to agree a new package for Greece.
Sarkozy may fly to Germany to meet with Merkel at the end of next week, a French official source told Reuters.
The sources all spoke on condition of anonymity because of the sensitivity of the negotiations.
Officials say France is staunchly opposed to any move which would constitute a credit event in the eyes of investors, triggering payment of Credit Default Swaps used to insure debt and sending shockwaves through Europe's financial system.
The derivatives industry body ISDA, which has the final say on whether a credit event has occurred, has said a voluntary agreement to roll over holdings of Greek debt would typically not trigger the payment of CDSs.
However, credit ratings agencies have said they would be likely to classify a rollover as a distressed debt exchange and downgrade Greece's rating to selective default. That could affect the European Central Bank's willingness to accept Greek debt as collateral in its liquidity operations.
There are a number of options on a table and negotiations are not over yet, said one source in contact with the finance ministry. A reprofiling of Greek debt would normally trigger a default, whereas a rollover would not.
NOT COMPLETELY VOLUNTARY
The French are determined to avoid any action that could damage not only Greece's creditors, its financial sector and economy but also have knock-on effects on the creditworthiness of Ireland and Portugal, and other stressed euro zone countries.
As an alternative to a debt swap, French sources say banks could be persuaded to enter into a voluntary agreement to roll over their Greek debt as it matures. However, that would mean official creditors paying more of the second bailout.
French banks are the second-biggest foreign holders of Greek debt after the Germans. BIS figures published this week showed that at the end of 2010, German banks held 23 billion euros in Greek bonds and French banks 15 billion euros.
ECB President Jean-Claude Trichet, a former French Treasury director, appeared to open the door to a rollover earlier this week by saying he would accept a scheme in which banks were asked to voluntarily maintain their level of exposure to Greece.
But he narrowed any such scope on Thursday by saying the ECB wanted to avoid any credit event and selective default.
To give banks an incentive to buy the new, longer-maturity bonds, the ECB could accept them as collateral, while the old ones could gradually cease to be accepted.
The question is can we try to convince the ratings agencies and package the deal so as not to trigger a credit event, said the source in contact with the Finance Ministry.
Bart Oosterveld, head of Moody's sovereign risk group, said on a trip to Paris this week it was hard to see how such an agreement would be truly voluntary, given the riskiness of Greek's 340 billion euro debt. If there was a suggestion of coercion it would likely trigger a default, he said.
Jean-Paul Chifflet, CEO of French heavyweight bank Credit Agricole, amongst the most exposed in Europe to Greece, said on Wednesday he was would favor an extension of Greece's sovereign debt maturities.
Another senior banker, speaking on condition of anonymity, said French banks had already given the government a commitment last year, at the time of the first Greek bailout, to maintain their exposure to Greece.
We were invited to a meeting with Christine Lagarde and she made very clear that she expected French banks, after all the government had done to support them at critical moments in 2008-09, to play the game on Greece, he said.
It wasn't extremely 'voluntary', he said, adding that the German banks had made a similar commitment.
(Additional reporting by Paul Taylor, Yann Le Guernigou and Emmanuel Jarry; Editing by Paul Taylor)