Tackling the European Sovereign Debt Crisis Stability at Last?

Transcription

1 Legal Update 15 March 2012 Tackling the European Sovereign Debt Crisis Stability at Last? The European sovereign debt crisis has been back on the agenda of European leaders since the beginning of the year. On 30 January, the 27 Heads of State and Government met during an informal European Council in Brussels. The meeting s official programme focused on growth and jobs and stressed the importance of three specific areas: youth unemployment, the Single Market and SMEs 1. At the same time, however, the summit endorsed two fundamental documents that will constitute the legal basis for the European Union s (EU) future actions against any crisis regarding the Euro: a new intergovernmental treaty on financial austerity referred to as the Treaty on Stability, Cooperation and Governance in the Economic and Monetary Union ; and a revision of the Treaty establishing the European Stability Mechanism (ESM), the Eurozone s permanent financial assistance institution. Since the beginning of the year, European leaders have also been discussing the situation in Greece, where negotiations between the government and its international creditors over a voluntary debt writedown have continued, all aimed at avoiding the risk of default of the country. Since 9 March 2012, these efforts can be regarded as obsolete since the ISDA EMEA Determinations Committee of the International Swaps and Derivatives Association, Inc. (ISDA) resolved unanimously that a Restructuring Credit Event has occurred with respect to The Hellenic Republic (Greece) 2. The Treaty on Stability, Cooperation and Governance in the Economic and Monetary Union Leaders from 25 EU Member States (all but United Kingdom and Czech Republic) signed the Treaty on Stability, Cooperation and Governance in the Economic and Monetary Union (in short SCG Treaty or commonly referred to as Fiscal Compact) in the margins of the European Council meeting on 1 and 2 March The SCG Treaty is an intergovernmental Treaty aimed at strengthening fiscal discipline in the EU. It introduces stricter surveillance within the Euro area, in particular by establishing a balanced budget rule at the core of the Eurozone Member States legal systems, as well as the possibility of imposing financial sanctions on signatory Member States in case of non-compliance. The SCG Treaty will enter into force on 1 January 2013 as long as at least 12 Eurozone Member States have ratified it (the first day of the month following the deposit of the twelfth instrument of ratification according to Article 14.2). It will then be applicable primarily to the 17 Eurozone Member States, while the other 8 non-eurozone signatory countries 4 will only be bound by the Treaty at the time they join the Euro 5 (unless they expressly declare their intention to be bound by all or part of the SCG Treaty in advance). 1 To that end, EU leaders issued a statement entitled Towards growth-friendly consolidation and job-friendly growth proposing a number of concrete measures to be implemented in these fields Bulgaria, Denmark, Hungary, Latvia, Lithuania, Poland, Romania and Sweden. 5 Most EU Member States whose currency is not the Euro have the obligation to eventually join the single currency as soon as they met the Convergence Criteria (Article Treaty on the Functioning of the European Union, TFEU). Only United Kingdom and Denmark have opt-outs from this obligation, granted respectively, by Protocols 15 and 16 to the Treaty of Lisbon.

2 The signature of the SCG Treaty has been welcomed with mixed reactions. The European Parliament, for instance, has noted that existing EU secondary legislation already provide for most of the measures included in the SCG Treaty and hence, has questioned the effectiveness of this instrument for tackling the crisis. They refer most notably to the measures contained in the Six-Pack, which were designed to strengthen the Stability and Growth Pact and which entered into force in December Moreover, a number of commentators and opposition parties throughout Europe have pointed out that focusing on plain austerity, as envisaged in the SCG Treaty, might not be the right economic policy. According to these critical voices, austerity may, in the short and medium-term, worsen the debt crisis, in particular of Southern European governments. It is questionable whether the SCG Treaty will ever have any effect other than giving justification for further credits to Greece or other means and efforts to collectivise the debt of European countries, because it will not have great effect if not signed by all Eurozone Member States and the success of the ratification process (in terms of ratifying what was originally agreed) remains very doubtful 6. Structure of the SCG Treaty Preamble Title I Purpose and Scope (Article 1) Title II Consistency and Relationship with the Law of the Union (Article 2) Title III Fiscal Compact (Articles 3 8) Title IV Economic Policy Coordination and Convergence (Articles 9 11) Title V Governance of the Euro Area (Articles 12 13) Title VI General and Final Provisions (Articles 14 16) Key Provisions Golden Rule Article 3.1 of the SCG Treaty establishes that Member States budgets shall be balanced or in surplus (the so-called budgetary golden rule). Accordingly, annual structural deficits higher than 0.5 percent of the respective GDP are prohibited. Member States with a government debt ratio significantly below 60 percent will be allowed to reach 1 percent GDP. At the same time, abiding by Article 3.1 will indicate that a Member State respects the limits of the mediumterm objectives defined in the Stability and Growth Pact as revised by the Six Pack. Correction Mechanism If the limits contained in Article 3.1 are not respected, a correction mechanism will be automatically applicable. The correction mechanism will be developed by each Member State on the basis of common principles proposed by the Commission, who will define the nature, size and time-frame of the fines, as well as the monitoring role of competent national authorities. Codification at National Level Within one year of the entry into force of the SCG Treaty, the golden rule contained in Article 3.1 shall be transposed into the national laws of the contracting Member States by means of provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be respected throughout the national budgetary processes. (Article 3.2). The final provision departs from the original intention of the Heads of State and Government which was to include the golden rule in the national Constitutions of all Member States. This greater flexibility is meant to make acceptance of the Treaty easier for reluctant Member States such as Denmark, whose Finance Minister indicated that the Danish Constitution, unmodified for 60 years, would not be altered in order to accommodate the Fiscal Compact s requirements. In addition, the change of national Constitutions usually requires a qualified majority of votes of the respective parliament which will in many Member States not be achievable. The fact that the SCG Treaty has only the status of an ordinary 6 For instance, see French Socialist president candidate François Hollande comments: For Spain and Netherlands, see: 2 Legal Update

3 national law draws more attention to the question how easily Member States can resign from the SCG Treaty or, in terms of international treaty, restrict their national sovereignty for budgetary matters. Surveillance and Financial Sanctions The final text of the Treaty confers a number of powers to the European Institutions, despite the initial opposition of the UK Government. The European Commission will exercise these powers jointly with the Council or individual Member States. However, the prevalence of Member States over the Commission is clear. In addition to the power of drafting the correction mechanism referred to above, the Commission will make sure that the Member States have codified the golden rule in their national legislations. Under Article 8.1, if the Commission concludes that a Member State has failed to comply with the obligation of Article 3.2 (that is, the national codification of the golden rule of budgetary discipline), the matter will be brought to the European Court of Justice by one or more of the other signatory Member States. Notwithstanding the Commission s role, any Member State can bring such matter to the Court at any time (Article 8.1). Member States will then have to comply with the judgement of the Court of Justice. Otherwise, in application of Article 8.2, if any Member State, on the basis of the Commission s assessment or its own, considers that another contracting party has not complied with the judgement of the Court regarding Article 8.1, it might bring the case to the Court requesting the imposition of a fine (maximum 0,1 percent of the Member State s GDP) in accordance with the criteria established by the Commission. The European Commission in cooperation with the Council will also be tasked with the mission of monitoring Budgetary and Economic Partnership Programmes to be developed by countries in excessive deficit procedures (Article 5.1) and reviewing Member States ex-ante reports on public debt issuance plans (Article 6). Finally, following Article 7, the Commission will be able to address proposals or recommendations to Eurozone Member States who are either in breach of the golden rule or immersed in an excessive deficit procedures. However, Eurozone Contracting Parties might avoid complying with the Commission s recommendations if they oppose to the Commission s decision by qualified majority (calculated by analogy with Article 16.4 TEU). Participation of non-eurozone Member States, European Parliament and other actors: Non-Eurozone Member States The Fiscal Compact Treaty is open for non-eurozone Member States (however, predominantly makes sense for Eurozone Member States), most notably the United Kingdom, to join the Treaty at any time. The last recital of the preamble specifies that non- Eurozone Member States ( Member States of the European Union with a derogation or an exemption from participation in the single currency ) can be parties of the Treaty following a piecemeal approach, that is, choosing those provisions of titles III and IV to which they intend to be bound. The participation of non-eurozone Member States is also enshrined in Article 1.2 on the scope of the Treaty. Following Article 12.6, non-eurozone Member States who have ratified the Treaty will be invited to participate in Euro Summit meetings on an ad hoc basis in order to discuss specific issues related to the implementation of the Treaty. European Parliament The final text of the Treaty addresses the European Parliament s concerns expressed in a critical motion for a resolution that rejected a previous draft of the Treaty and demanded a greater role for the Parliament. Article 12.5, dealing with the governance of the Euro area, foresees that the President of the European Parliament may be invited to Euro summit meetings and establishes that after each of such meetings, the Euro Summit President should present a report to the European Parliament. Eurogroup The President of the Eurogroup has now a diminished role in the governance of the Euro area. The Eurogroup will continue assisting with the preparation and follow up of the Euro Summit, but its President will only be invited to the Euro Summit meetings for discussing the details of the Eurogroup s assistance. mayer brown 3

4 National Parliaments According to Article 3.3, the correction mechanism applicable in cases of breach of the golden rule, to be implemented at Member State-level following common principles proposed by the Commission, shall respect any prerogative of the national Parliaments established by national law. In addition, Article 13 establishes that national Parliaments of the contracting Member States will join the European Parliament in a conference of the chairs of the budget committees of national Parliaments and the chairs of relevant EP Committees. The ESM Treaty On 2 February, Eurozone Member States signed a revision of the ESM Treaty. The new version, agreed at the 30 January summit, enhances the functioning of the permanent international financial institution that will substitute the EFSF. The ESM will be operational as from July 2012 as soon as Member States representing 90 percent of its capital (EUR 700 billion, of which EUR 80 billion are direct contributions by Member States and the rest are guarantees) ratify the Treaty. According to its founding treaty, the ESM is an intergovernmental organization governed by public international law based in Luxembourg. Unlike its predecessors, the ESM will provide a permanent bail-out arrangement for the Eurozone. It will be based on actually paid-in capital, rather than relying on contingent guarantees to underpin its lending facilities which adds credibility. In the event that further financial assistance is needed, the ESM may also borrow funds from banks or capital markets. As the ESM Treaty points out, Member States are liable for their own capital contributions, therefore ESM does not legally mutualise the debt of the Eurozone even if this may be the case from a practical point of view. The ESM will be able to use all instruments currently available for the EFSF (loans, precautionary financial assistance programmes, purchase of sovereign bonds and recapitalisation of Eurozone Member States ailing financial institutions) and have a maximum lending capacity of EUR 500 billion. This amount is not considered to be sufficient for facing an eventual rescue of big Eurozone economies such as Italy or Spain. For this reason, during the 1 2 March European Council, EU leaders confirmed their commitment to re-assess the adequacy of the overall ceiling of the EFSF/ESM by the end of April, to accelerate in full respect of national parliamentary procedures the payment of the paid-in capital for the ESM, starting with the payment of 2 tranches in 2012, and to agree before the end of March on a revised timeframe for the payment of the remaining tranches. The ESM is equipped with several instruments for financial assistance. It can provide credit line arrangements which may be employed as precautionary measures. But it may also provide direct financial assistance in order to re-capitalize ailing financial institutions. Furthermore ESM s support engagement may be devoted to both primary and secondary markets: In the context of the primary market support facility the ESM will make a purchase arrangement for bonds upon issuance on the primary markets. Whereas the secondary market support facility entails ESM s arrangements for operations on the secondary markets which are especially designed to tackle the risk of financial contagion. The ESM and SCG Treaties are closely interconnected. Only those Member States who have ratified the SCG Treaty and eventually comply with its rules would be able to obtain financial assistance from the ESM. Notwithstanding the above mentioned support facilities it is uncertain whether the ESM may be able to guarantee that there will always be cash on hand to pay out sovereign bondholders. Unanimity on the part of the ESM s board of governors will be required in order to liberate cash injections except in the case of emergencies, when a qualified majority will apply. Accordingly, each country maintains a veto power. Therefore, ESM s governance structure does not appear to be entirely suitable for effective crisis management. Finally, it is a condition for assistance under the ESM Treaty that a standard Collective Action Clause (CAC) is included in all new government bonds being issued from 1 January 2013 with maturity over one year by any Eurozone Member State. However, the required standard CAC provision is not yet specified under the ESM Treaty and may be subject to further elaboration. 4 Legal Update

5 The Second Greek Bail-out and the Private Sector Involvement (PSI) Discussions The second bail-out programme for Greece, originally agreed in July 2011 (EUR 110 billion) and revised in October 2011 (EUR 130 billion), has not been put in place yet. In the aftermath of the 23 January Eurogroup meeting, its president, Jean-Claude Juncker, pointed out that the Greek programme was off track and stressed that its execution was conditional on two requirements: Greek government to, first, adopt further austerity and liberalisation reforms and second, reach a PSI agreement with its bondholders. The second rescue programme as revised in October 2011 included a Private Sector Involvement (PSI) package designed to reduce the EUR 206 billion Greek private debt by 50 percent (from 160 percent GDP to 120 percent by 2020). The agreement between EU leaders and the Institute for International Finance (IIF) implied that private creditors would voluntarily accept a 2:1 reduction of their debts, a formula which would not only reduce their expected returns, but also deactivate the credit default swaps that would be triggered in the event of an involuntary write-down (i.e. a credit event) or default scenario. The IIF, negotiating with the Greek Government on behalf of Greece s creditors, argued that a 4 percent interest rate for new bonds with a 30 years maturity would be necessary in order to be able to meet the requirements of the agreed PSI package, but Greece (compelled by the Eurogroup and the International Monetary Fund) could not accept interest rates higher than 3.5 percent. On top of the struggle over the details of the package, the political situation in Greece is not optimal as general elections will be held on 8 April 2012 amid widespread social unrest. A Greek default is seen as unavoidable in case the second programme is not activated, as Greece faces without significant funds on hand EUR 14.5 billion bond redemptions which are due in March On 6 February, France and Germany held a joint Ministerial Council in Paris and proposed the creation of a separate fund to be used as collateral to pay Greece s creditors in case of default. On 23 February the Greek parliament passed the Greek Bondholder Act (Law 4050/2012) allowing the biggest sovereign debt restructuring ever attempted. Greece has agreed on a debt restructuring transaction with the private sector, which is a precondition for the second bailout package worth 130 billion Euro. Under the PSI scheme which is considered to be voluntary in principal, it is expected to include private bondholders of approximately EUR 206 billion of Greek bonds. A bond swap will take place in order to exchange existing debt held by private sector investors for three types of new debt instruments: First of all, by introducing a Collective Action Clause (CAC) with retroactive effect Greece is now able to impose a 53.5 percent haircut from par value on debt held by private sector investors, thus avoiding a bailout. Since there is no orderly bankruptcy regime for sovereign entities, CACs are used to mitigate the problem of holdout creditors: If two-thirds of a quorum of at least 50 percent of all creditors agree to the bond swap and subsequent haircut, Greece would be able to activate the CAC forcing resistant bond holders to follow suit. If existing bond holders are not accepting the proposed debt restructuring they may thus be faced with a unilateral amendment of contractual conditions ( retrofitting ). This will however only apply for those bonds which are governed by Greek law. While the existing debt instruments are mostly governed by Greek law (177 out of 206 billion Euros) and thus being subject to CAC, the question arises of how the remaining bonds should be treated which are not governed by local law. For those bonds which Greece has issued under English law (with English jurisdiction), English Courts would not recognize any Greek law imposing changes on the terms and conditions of the bonds. Since outstanding bonds of Greece under English law already provide for CAC, such restructuring may only take place by getting the respective majority of noteholders for any debt restructuring 7. This means that these bonds have to be restructured on a bond-by-bond basis which enables some creditors to built up blocking positions more easily. With regard to the newly issued debt instruments being offered in exchange to the existing bonds the PSI pursues a threefold restructuring approach: In contrast to the existing bonds which were mostly governed by Greek law, the first part of the bond swap consists of newly issued bonds entirely governed mayer brown 5

6 by English law, having a 35 percent face value of the original debt. There will be a negative NPV (Net Present Value) effect not only due to the maturity stretch as the newly issued bonds will only be maturing in While solely bonds governed by local Greek law may be retrofitted by CAC the Greek Government will not be able to impose similar contractual changes to the newly issued tranche. Due to the fact that the newly issued bonds are governed by English law this seems to entail a favourable treatment involving standard creditor protections such as explicit equal treatment of bondholders (pari passu) or negative pledge clauses. However, given that Greece debt restructuring programme has already triggered a Credit Event under various credit derivative contracts or equivalent financial instruments and Greece will seek to find a way to get rid of part of those bond obligations governed by English law where bondholders have not voluntarily accepted a cut, there is not much inhibition left to tell bondholders in the future bluntly that they simply do not receive their money back. As a second part the bond swap also comprises a newly issued public-debt vehicle stemming from the European Financial Stability Facility (EFSF) as part of the co-financing package to Greece. These notes acting as sweeteners will be amounting to 15 percent of the original bond s face value and will mature within the 24 month subsequent to the issuance. The third type of newly issued securities represent GDP-linked debt instruments. A similar type of bond was employed after Argentina s default and has provided investors with returns upon revival of the Argentinean economy. While having face value as notional value there is a substantial level of uncertainty involved as the critical question resides in Greece s barely foreseeable future economic growth. Consequences of the Private Sector Involvement (PSI) on Financial Products linked to a credit event in Greece As mentioned above on 9 March 2012, the ISDA EMEA Determinations Committee of the International Swaps and Derivatives Association, Inc. (ISDA) resolved unanimously that a Restructuring Credit Event has occurred with respect to The Hellenic Republic (Greece). The committee determined that the Restructuring Credit Event occurred under Section 4.7(a) of the ISDA 2003 Credit Derivatives Definitions (as amended by the July 2009 Supplement). Despite recent statements of ISDA that the retroactively introduction of collective action clauses themselves would most likely not constitute a credit event, the committee determined that the use of such a clause to effect a reduction in coupon or principal or one of the other events set out in the definition of the Restructuring Credit Event could trigger a credit event if the other requirements of the Restructuring Credit Event were met (for example decline in creditworthiness), as its effect would be to bind all holders of the relevant debt. CDS contracts which follow very often the recommendation of the ISDA matrix include usually Restructuring as a credit event. The Committee further determined that an auction will be held in respect of outstanding CDS transactions on 19 March. ISDA published a list of obligations issued or guaranteed by The Hellenic Republic, which the EMEA Determinations Committee currently reviews 8. The auction settlement terms shall enable the parties involved to auction covered transactions to settle such auction covered transactions based upon an auction final price determined according to the auction procedure. For physical delivery, ISDA publishes a list of deliverable obligations 9. Because the acceptance period of the Greek sovereign debt exchange is rather short (expires on 23 March 2012), ISDA has also shortened the Physical Settlement 7 For those obligation of Greece which are guarantees for corporate bonds, attention must be paid to the exact wording of the guarantee and whether it covers any eventuality that may occur to the debtor (including any rescheduling of debt in connection with an insolvency proceeding). 8 The list can be accessed under: Answers to frequently asked questions regarding The Hellenic Republic Restructuring Credit Event can be accessed via ISDA s Greek Sovereign CDS page: 9 Link available under 6 Legal Update

7 Period for the International Law Obligations so that the recipients of such bonds may have full option to participate in the tender offer. The Auction Date will be 19 March 2012 and the Exercise Cut-off Date is 16 March To the extent any eligible market participant wishes to propose an additional obligation not on the Initial List to be considered for inclusion on the Final List, it must sent to the DC Secretary by 5.00 p.m. (London time) on Tuesday 13 March 2012 a proposal for inclusion of such obligation. The DC Secretary will publish the Supplemental List on its Website at or about 7.00 p.m. (London time) on Tuesday 13 March Protection seller that will likely receive Greek sovereign bonds (or guaranteed bonds) in the course of the physical delivery should be ready before the actual delivery with their analysis and required internal approval process deciding whether they want to accept the debt exchange or not. As mentioned in our previous newsletter 10 ISDA deemphasized the impact of a credit event in respect of Greece under CDS, stating that the net exposure of protection sellers on Greek sovereign debt was approximately USD 3.7 billion as of 21 October 2011 (according to Depositary Trust & Clearing Corporation s CDS data warehouse) alleviated again by recovery values of underlying obligations and collateralization between 70 percent and 90 percent. It was further mentioned that most banks had already written off most of their losses in CDS protection seller positions because they were obliged to mark-to-market them 11. However, it should not be left unmentioned that CDS are not the only weapons outstanding in the market and that CDS-like structures have also been used in connection with very complex, bespoke and opaque financial instruments like collateralised debt obligations with Greece as reference entity and where the above mentioned valuation method or transparency rules are only to a certain extent used. 10 See Pratt s Journal of Bankruptcy Law, Volume 8, Number 1, January 2012: THE EUROPEAN SOVEREIGN DEBT CRISIS PAVING THE WAY TOWARDS FINANCIAL STABILITY by Marius A. Boewe, Salomé Cisnal de Ugarte, Simon G. Grieser, Andreas Lange, Jens Peter Schmidt, and Jörg Wulfken, page and If you have any questions or require specific advice on any matter discussed in this publication, please contact one of the lawyers listed below: Dr. Marius Boewe Partner, Düsseldorf T: mboewe@mayerbrown.com Dr. Salomé Cisnal de Ugarte, LL.M. Counsel, Brussels T: scisnaldeugarte@mayerbrown.com Carsten Flasshoff, LL.M. Partner, Düsseldorf T: cflasshoff@mayerbrown.com Andreas Lange Partner, Frankfurt am Main T: alange@mayerbrown.com Kai Liebrich Partner, Frankfurt am Main T: kliebrich@mayerbrown.com Dr. Jörg Wulfken Partner, Frankfurt am Main T: jwulfken@mayerbrown.com

8 Mayer Brown is a global legal services organization advising many of the world s largest companies, including a significant portion of the Fortune 100, FTSE 100, DAX and Hang Seng Index companies and more than half of the world s largest banks. Our legal services include banking and finance; corporate and securities; litigation and dispute resolution; antitrust and competition; US Supreme Court and appellate matters; employment and benefits; environmental; financial services regulatory & enforcement; government and global trade; intellectual property; real estate; tax; restructuring, bankruptcy and insolvency; and wealth management. OFFICE LOCATIONS AMERICAS: Charlotte, Chicago, Houston, Los Angeles, New York, Palo Alto, Washington DC ASIA: Bangkok, Beijing, Guangzhou, Hanoi, Ho Chi Minh City, Hong Kong, Shanghai, Singapore EUROPE: Brussels, Düsseldorf, Frankfurt, London, Paris TAUIL & CHEQUER ADVOGADOS in association with Mayer Brown LLP: São Paulo, Rio de Janeiro ALLIANCE LAW FIRM: Spain (Ramón & Cajal) Please visit our web site for comprehensive contact information for all Mayer Brown offices. Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the Mayer Brown Practices ). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC ); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. Mayer Brown and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions The Mayer Brown Practices. All rights reserved. 0312