«Why have issues such as the Hellenic Republic’s €150,000,000 Floating Rate Notes due 2012 performed so well recently, whilst the rest of the debt has been plummeting?»This is the striking and apt question that opens the excellent article published in the Blog: Right to the Bottom by Juan Ramón Caridad and Jacobo Zarco in FundsPeople. And the authors’ immediate response is the difference between local regulations and English regulations.
That is why, in the event of a credit event, it makes a world of difference whether an issue is governed by Greek law—which leaves it open to all sorts of possibilities—or, for example, by British law. We saw a clear example of this during the credit events in Russia, where defaults affected debt denominated in roubles governed by Russian law, but not debt governed by US law. In other words, in critical situations, the prices of issues that in boom times may be indistinguishable to most investors (including well-known institutional ones), in times of credit events or stressed situations, Mr Market certainly does distinguish. And how he does. Logically, when we talk about sovereign debt in USD governed by US law or in local currencies under local regulation, arbitrage—which is non-existent in calm times—becomes a substantial business in times of stress.
This seemingly uniform form of debt discrimination became particularly apparent in the summer of 2007, when the then-unknown subprime crisis began to separate the good from the not-so-good, and the bad from the worst. It was from then on that most financial institutions had to roll up their sleeves and read the small print of every debt issue carefully. In other words, to learn to distinguish between sheep and goats that until then had grazed in apparent harmony on the green pastures of pre-subprime fixed income. Some failed to do so in time and suffered the consequences, whilst others acted more swiftly, yet the tsunami of junk securitisations swept them away too. The toxicity of debt in those years (it feels like yesterday, but we’re talking about almost five years ago now) contaminated everything it touched, especially non-senior debt with maturities and insolvent issuers. Ah, those were the days when you could still find plenty of solvent issuers in the developed world. These days, you wouldn’t find them even if you looked under every stone, with rates barely above the Euribor and little else. And when you do find a «gem», as we usually call it, the issuers call the issue early at the first legal opportunity they get. That’s the downside of being solvent, although obviously if we’re not clear on the concept of solvency, the market offers issues with tempting yields galore. 
And this is becoming more and more the case. But when the credit that still flows through the developed fixed-income market dries up, the bottleneck will be dramatic. And we will see giants with feet of clay fall—giants we would never have thought to see go bust. The same could obviously happen to financial institutions once their state-backed parent companies finally collapse. Of course, the politically correct line will be that they are neither technically bankrupt nor insolvent, but that it is merely a temporary lack of liquidity… But, for heaven’s sake, If there were infinite liquidity, insolvency would not exist!
Returning to Caridad and Zarco’s article, the negative pledge makes all the difference in the event of a debt default. And with regard to Greek debt, they say the following: «And what is this »negative pledge”? Why, whilst the risk premium was plummeting, was there a Greek debt issue worth around 400 million that just kept rising?’
You can download it here the prospectus for the issue referred to at the beginning of the article. Please note the clause on page 7 entitled “STATUS OF THE NOTES AND NEGATIVE PLEDGE». Quoting the FundsPeople article: «The fact that an issue contains this clause means that no other creditor may be treated more favourably than the bondholder, and this includes the International Monetary Fund and the European Central Bank. It goes without saying that in any bankruptcy and subsequent restructuring process this is a particularly important right, but it is essential to ensure that such an issue is not arbitrarily treated in a detrimental manner, as has occurred in Ireland. The legal departments of some asset management firms have sent a letter to the incoming Greek minister to confirm that they are aware of what the Negative Pledge entails. Athens has not only responded to this letter, but has done so positively.«
In other words, even in times of extreme financial distress, such as the situation Greece is currently facing, negative pledge clauses and the jurisdiction governing the debt issue are sacrosanct. Some people would do well to make their peace with God while they still can.