While much of the headlines and attention coming out of the weekend is focused on the S&P downgrades of France, Austria, and other European nations the more important theme for this week will be how the negotiations about Greek restructuring fare.
The failure to strike a deal by the end of the week could mean that Greece is unable to pay back €14.5 billion which is maturing on March 20th, and that could mean that it is forced to either seek a more coercive restructuring, an out-right default, or that European governments will need to put in more funds to satisfy the demands of the creditors.
Greece creditors broke off talks last week as that Institute of International Finance has said that the financial firms it represents have not come up with a constructive consolidated response by all parties.
Back in October, at an EU summit the plan was to implement a 50% haircut on the face value of Greek debt, with the parties trying to cut Greece's debt to GDP ratio to 120% by 2020. Many of the big banks agreed - under intense political pressure - but there is still a large holdout contingent - mainly hedge funds - that are driving a harder bargain.
The current issue revolves around the new 30 year bonds to be issued by Greece. Many of the other issues on hand have been agreed upon over the last several weeks.
From Financial Times: Greek debt managers had agreed with bondholders on a coupon just below 5 per cent but some governments last week proposed a much lower interest rate.
Germany has proposed a 2-3 per cent coupon that would increase bondholders' losses from 60 per cent to more than 80 per cent in net present value terms.
The interest rate and other terms must be attractive enough to ensure voluntary participation and the maximum number of interested parties, said one person close to French bondholders.
From Financial Times: Jacob Funk Kierkegaard at the Peterson Institute of International Economics in Washington said: The IMF has said that either Greece needs 100 per cent ... participation [from bondholders] or the euro area authorities have to make up the shortfall. The euro area now has to decide whether they want to pony up another €30bn or so or force a coercive restructuring.
These hedge funds want to be either paid out in full or they will not go along with a voluntary restructuring and therefore would demand to have credit default swaps paid out in full. In order for credit default swaps to not be triggered the debt restructuring needs to be voluntary and have a large participation.
What has happened is that while many hedge funds owned credit default swaps the implication was that they would not be paid out because of the voluntary nature of the negotiations. What then has happened is that in the fourth quarter hedge funds have bought up distressed Greek bonds and have enhanced their position in terms of being able to affect the negotiations.
Talks are set to resume on Wednesday and because of the paperwork and legal ramifications involved a deal would have to be finalized by the end of this week in order for that €14.4 billion bond redemption due on March 20th to be paid out.
As a result the clock is ticking and if negotiators are unable to come to an agreement it could throw the financial markets in Europe into a tumultuous storm as it undercuts confidence and spreads contagion to other sovereign bond markets.
Sub-ordination Another Important Factor to Consider from Greek Negotiations
The extra wrinkle here is that despite politicians claims at the December 8th EU Summit that no more private sector involvement (PSI) would be sought in any future restructuring the concern is still out there for creditors of Portugal, Ireland, Italy, and Spain.
Their debt is likely to be subordinate to the ECB and the ESM - the permanent bailout mechanism - and the end result of the negotiations with Greece could be used as a template in further iterations of restructurings.
From ZeroHedge: As a reminder, it was again back in June we predicted that the key phrase (or two) in the proposed package: Voluntary and Collective Action Clauses. Why? Because what this does is unleash the prospect of yet another word, which is about to become one of the most overused in the dilettante financial journalist's lingo: subordination or the tranching of an existing equal class of bonds (pari passu) into two distinct subsets, trading at different prices, and possessing different investor protections (we use the term very loosely) with the result being an even greater demand destruction for sovereign paper.
If collective action clauses aren't binding on the ECB it's hard to see how they could be binding on others, said the hedge fund manager. If bonds bought by the ECB are de facto senior, it turns the SMP into a double-edged sword. For every Italian bond the ECB buys, that could be less Italian debt servicing power for everyone else.
The de-facto turning of the sovereign bond markets into two-tiered structures, with certain bonds subordinated to others will create further uncertainty and can undermine efforts by politicians to restore confidence in the periphery bond markets, and was cited by the S&P in its downgrades from Friday.
While the short-term focus will be on what to do with Greek restructuring, and that will dominate the headlines this week, other larger issues loom, which means there won't be much reason for the pressure on the Euro to ease in the coming weeks and months.