Seniority, the SMP, and the OMT
They’re noting something curious about ECB seniority in light of Thursday’s revelations about the OMT. The ‘technical features’ confirm that the OMT will receive equal treatment with ordinary bondholders if a eurozone sovereign restructures its debt. But, in the Q&A, Draghi also confirmed that the old SMP bond holdings will remain senior. It will be first in the queue, ahead of bondholders and the OMT.
Well, we’d say no to Macro Man’s question itself.
First, it’s not been clear for a while whether writing down private bondholders would be all that effective at reducing Portugal’s debt, as so much of it is already in official hands. Second, this could (for all we know) be more about the SMP’s remaining Greek bonds than its Portuguese holdings. Write-downs by Greece’s official creditors, including the ECB, are maybe closer than Portugal PSI.
But you do have to ask the question. Maintaining SMP seniority is so odd, next to the breath of fresh air of making the OMT equal with private bondholders, that it’s hard to find a good reason for it.
The broader brushstrokes of the SMP’s exclusion from debt restructuring — the ECB can’t finance a sovereign through writing down claims on it, as per Article 123 of the EU Treaty — are surely more difficult to understand now, given the OMT is also a monetary instrument.
It’s not an odd but small problem, either. The SMP holdings still total some €200bn. Also, in the coming months Portugal could quite conceivably meet the ECB’s criterion of “regaining bond market access” for OMT purchases of bonds. Ireland’s pretty clearly already accessing the market. Conceivably then, that could lead to the central bank being pari passu on some Portuguese or Irish bonds under the OMT, but being senior on some other of those bonds. Which would be confusing.
The market access criterion itself could be confusing, JPMorgan’s Malcolm Barr argues:
We had expected the ECB to reinforce Draghi’s message today by intervening in Portugal, which is already compliant in a full program. The rather arbitrary choice of timing on when to intervene undermines the notion that the OMT is about the transmission mechanism…Regarding interventions in existing program countries, these could still happen soon: Ireland has re-entered capital markets already, and the Portuguese program anticipates a return to markets in the coming year. The ECB is surely aware that the ability of a program country to re-access markets will not be independent of the central bank’s behaviour.
Maybe we’re looking a gift horse in the mouth here; the OMT’s commitment to pari passu status looks pretty strong – enshrined in the legal act setting up the new bond purchases. Above all there seems to be no complicated trickery here: no use of the bailout funds to indemnify the ECB balance sheet, no restriction of buying to T-bills. Both ideas had been floated before Thursday’s meeting. You also really have to have been there to appreciate the damage done by the ECB’s protection from the Greek PSI, and therefore to appreciate the shift in tone that’s now come in with the OMT.
But that, really, makes the SMP exception rankle even more than it should.
Update — Of course, as the ECB said in the OMT release, it is pari passu… “in accordance with the terms of such bonds”.
As David Nowakowski, fixed income strategist at Roubini, reminded us on Thursday: eurozone sovereign bonds — whether acquired through the OMT or the SMP — do not inherently give the ECB any special rights to seniority.
The SMP seniority only activated when Greece switched the ECB’s holdings into special securities protected from restructuring. Therefore, as Nowakowski notes, nothing has changed in the bonds’ terms. That means the ECB could, if hell-bent on avoiding losses through a restructuring, stay legally ‘pari passu’ but effectively senior anyway. As Nowakowski pointed out in a recent note:
The ECB can promise to be pari passu, until a default threatens and it can then pressure Euritania to let it swap into local or international bonds without CACs that receive special treatment, exactly as it did with Greece. They could still argue, though not in good faith, that those bonds are not senior to anyone, they just got lucky again to get such a great offer. The ECB has tremendous leverage on countries whose banking systems depend on it for funding, so it can call the shots.
The point, really, is that eurozone sovereign debt is overwhelming governed by the domestic law of the issuer. Making it easier, if deemed necessary, to change the law to protect the ECB, technically pari passu or not.
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