LONDON (Reuters) - The European Central Bank could scupper future euro zone debt restructurings if it increases the amount of a country’s bonds it can buy under its economic stimulus programme, a top debt lawyer has warned.
The problem, on the radar of European authorities suffering a hangover from the 2012 crisis, has been pushed to the fore by expectations the ECB will need to raise limits on its bond purchases to keep its quantitative easing scheme on track.
Kai Schaffelhuber, a partner at law firm Allen & Overy, said that if the ECB permitted itself to buy more than a third of a country’s debt it would make a restructuring of privately-held bonds more difficult, a move that could increase the likelihood of taxpayer rescues.
In a debt restructuring, a quorum of investors, which can vary in size, has to agree the terms of a deal. The ECB cannot participate because it is forbidden from directly financing governments.
“They (the ECB) should avoid a situation where they are holding so much (of a) debt that a restructuring becomes virtually impossible,” said Schaffelhuber, whose firm worked on Greece’s 2012 debt restructuring.
A public backlash at the billions of euros spent in bailing out euro zone countries and their banks over the last six years has given rise to a raft of legislation aimed at ensuring private investors share the pain in future defaults.
Yet desperate to lift growth and inflation, the ECB and national central banks started buying government bonds early last year in order to drive down countries’ borrowing costs and spur cheaper lending to businesses.
The ECB initially limited its purchases to 25 percent of each individual bond and a third of a country’s outstanding debt, saying it wanted to mitigate the risk of becoming a dominant creditor of governments. After six months it raised the issue limit to a third for all bonds, except for a minority which have specific restructuring clauses known as collective action clauses.
Some market analysts think the ECB could raise either one or both of these thresholds again, as soon as September, amid signs it is approaching overall limits in Portugal and Ireland, and as yields on many German bonds fall below the ECB’s deposit rate - the lower limit for purchases.
ECB President Mario Draghi declined to address the issue at its policy meeting last week, but said technicalities would not stand in the way of the asset buying and that the ECB would review the programme if necessary.
Schaffelhuber said that as bonds have varying restructuring clauses and are issued under different laws, it is difficult to say how big a stake would block a deal. But he said buying up to 50 percent of overall debt would “almost certainly” result in an “impasse” in negotiations. The bigger the stake the ECB holds, the more difficult it is for other investors to form a quorum.
Under this scenario a public bailout becomes the most likely solution, although Schaffelhuber said there could be a fudge whereby the ECB agrees to extend the repayment schedule of bonds or reduces interest payments. This provides relief but is not legally equivalent to forgiving debt outright, he said.
Rodrigo Olivares-Caminal, chair in banking and finance law at London’s Queen Mary University agreed that the ECB could create “complications” in a restructuring if it built a large stake, but added that “with these things there tends to always be a way”.
Just five years ago German politicians and the Bundesbank insisted the ECB could not and would not buy government bonds but, as it ran out of other ways to stimulate growth, legal and political resistance to QE evaporated.
Some investors argue that in building ever larger stakes and reducing the risk of debt restructurings, the ECB effectively cuts the credit risk for other bondholders - which in turn retains market access at affordable interest rates for the sovereign and lessens the need for future bailouts.
“If you are going to allow that government to continue to issue, and you continue with your bond buying, then the music doesn’t stop,” said Hani Redha, portfolio manager at PineBridge Investments.
Quantitative easing is scheduled to run until March 2017, although the ECB has kept the door open to an extension, which most analysts think likely.
The longer the scheme runs, the more likely the ECB is to build a dominant stake, leaving few private investors to share the burden of another debt crisis.
Additional reporting by Marc Jones Editing by Jeremy Gaunt