PSI Update

Uncertainty over the participation in the Greek bond swap is a major source of anxiety today. Rumors circulated earlier that the PSI "invitation" would be extended by a week due to low participation have been officially denied, but rumors themselves illustrate the market's apprehensions.

It does appear that participation will be sufficient to incorporate the collective action clauses (66%), but not the 90% official goal. The Greek government has signaled willingness to invoke the CACs, if necessary. This may have been an attempt to demonstrate its resolve as surely the preferred outcome is to maintain the veneer of voluntarism. Moreover, invoking the CACs would most likely be regarded as a credit event by ISDA and trigger the credit default swaps.

Of the 13-member IIF steering committee, 12 indicated they would in fact participate in the PSI. The one holdout, thus far, is the Landesbank Baden-Wuerttemberg, from Germany. Ironically, German banks reportedly accounted for more than half of the 800 banks that participated in LTRO II and some observers saw a link between LTRO participation and PSI participation.

In any event, the 12 IIF steering committee that will participate account for an estimated 40 bln euros. Greek and Cyprus banks have indicated, according to reports that they will participate as well. They account for roughly another 40-45 bln euros. That brings the back of the envelop calculation to about 80-85 bln euros. To put the CACs into place, Greece needs to get 50% of all the bonds in question (in private hands and under Greek law), which is approximately 177 bln euros. Thus at this juncture officials can be confident that the CACs will be adopted.

However, there is almost 20 bln euros of Greek bonds that are governed foreign law, primarily English law. And it appears that this is where some hedge funds are trying to secure a blocking position. For example, some press reports suggest that a CHF2.12 bln bond is one of the focal points for this strategy. Hedge funds are believed to hold at least 30% of this issue and are trying to organize themselves to secure a blocking position that would ensure either being paid in full by Greece, or triggering the CDS that would make them whole.

In recent days, the prices of Greek CDS has risen as more investors suspect that they may be triggered after all and hence seek protection.

On balance, the current available information set suggests participation is coming in around 75-80%. The low end would more than likely see the CACs triggered. At the high end--say 80-85%--and it is possible the Greek government does not trigger the CACs.

If the CACs are triggered, there is likely be fallout in the peripheral countries, including Spain and Italy. There is also likely to be negative repercussions on financial sector shares. Currencies like Australian and New Zealand dollars as well as the Swedish krona would likely be sold off. Among the majors, the US dollar and yen are likely to outperform. Emerging market currencies would in general also be sold off. Equities would be sold. Core bonds, like Germany, UK and US would likely outperform.