Vulture funds prepare to battle Greek default

Funds thought to hold blocking stake in some foreign law bonds

Legal battle could last for many years

Greece looks set to face a protracted legal battle with so-called “vulture funds” over large chunks of its foreign law-governed bonds, regardless of the outcome of the ongoing negotiations to restructure its debt.

Distressed debt funds began targeting Greek foreign-law bonds last year with an eye to building up a big enough stake to hold out against, and ultimately profit from, a Greek restructuring. Funds such as Elliott Associates have deployed this tactic successfully in past sovereign restructurings such as Argentina and Peru.

The total amount of Greek foreign law debt is fairly sizeable at €18.5bn, just under 10% of the €200bn of Greek bonds subject to the private sector involvement. Traders now believe distressed funds have managed to build up blocking stakes in some of these bonds.

Market participants expect Greece to decline to pay out on these bonds if hold-outs manage to block a restructuring by building up more than 75% in a particular issue. At the same time, funds are preparing other legal arguments to recover their investments, which could take years for courts to resolve.

“We’ve heard that these funds have big enough stakes in some foreign law bonds [to block a restructuring] – I know some people at small funds and some correlation desks that hold these positions,” said the trader in charge of distressed sovereigns at a major bank.

“If there is only one bond that is blocked, Greece will probably pay it out as it’s not a big deal and they don’t want to set a precedent. But the likeliest outcome is that it’ll be more than one bond. I believe there’ll be a failure to pay on [the foreign-law] bonds because Greece is bust and no one wants to pay these free-riding hedge funds,” he added.

Much uncertainty continues to surround the outcome of the Greek debt restructuring.  Provided it goes ahead, though, collective action clauses will likely be inserted into Greek bonds. If a majority, normally either 66% or 75% of holders of a particular bond by value, then agree to the restructuring, the CAC will bind all holders of that bond to the restructuring.

Foreign law bonds were targeted by vulture funds as they are mainly subject to English law, and therefore claimants feel they would have a better chance of reclaiming their investment. These bonds have consequently traded at a premium to domestic law bonds.

For example a SFr650m 2.125% bond maturing July 2013 has risen by 15% over the last month to 40.6% of its par value, whereas many Greek law bonds are now trading at between 20% and 30% of par.

Due to the opacity of secondary bond markets, it is impossible to know whether vulture funds have built up a big enough stake in certain bonds to block their restructuring. However, sources on both market-making desks and at buyside firms believe the vulture funds have been successful.

“We never see any offers on English law debt, even though there is a fairly active market in GGBs more generally. I definitely think they have enough of a blocking stake,” said one hedge fund manager who trades sovereign debt.

Prolonged legal battle

Even if Greece opted not to pay the foreign law bonds, it could still face a prolonged legal battle. If the ECB participates in the bond exchange as now expected, this may eliminate a potential line of argument for distressed investors: preferential treatment for the central bank to the detriment of other creditors.

However, Steven Friel, a litigator with law firm Brown Rudnick, which specialises in representing funds in these types of cases and is actively following the Greek situation, noted there are a number of other options available to holders of foreign-law bonds should Greece default.

The most obvious route would involve bondholders suing in the English courts, similar to the cases being brought by holders of Irish bank debt following the restructuring last year. They could also bring an action in the Greek courts on constitutional grounds. Another option would be to claim the default breaches the European Convention on Human Rights for effectively confiscating the funds’ property.

Finally, Friel said investors might take action against Greece in an international arbitration tribunal under the auspices of one of the 38 bilateral investment treaties, which Greece has entered into with other states including Germany, for expropriation of their investments by the Greek government. A group of Italian investors are still pursuing this path against Argentina, despite it defaulting on its debt over a decade ago.

“I would be very surprised if any investor has bought up these bonds without having thought through a strategy of how it is going to recover on its investment,” added Friel, who declined to comment on particular clients.


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