Analysis: Euro zone bond clause highlights rich nation default risk

Fri Dec 28, 2012 8:33am EST
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By Marius Zaharia

LONDON (Reuters) - When 10 wealthy countries first demanded legal provisions making it easier to restructure government bonds in a crisis, they never thought this would apply to their own debt.

A decade ago the Group of 10 had places like Argentina or Mexico in mind, and yet from next week new euro zone government bonds will include these "collective action clauses" (CACs).

Applying such clauses - which can force investors to accept big losses on their bond holdings - acknowledges that a developed country can go bankrupt and debt default is no longer the preserve of emerging market governments.

From its own perspective, the euro zone has sound reasons for inserting the clauses. An absence of CACs on many Greek bonds allowed hedge funds to make big profits by dodging a write down of the country's privately-held debt earlier this year.

From January 1, 2013 all newly-issued euro zone government bonds will carry CACs, making it the first developed market to impose such clauses routinely.

They will allow a two-thirds majority of bondholders that agrees to a restructuring to force a dissenting minority to participate. In future, everyone will have to share the pain, should a government go the same way as Greece and need to cut its debt burden radically to avoid defaulting.

The aim is to make it easier and less costly for a government to restructure its debt. At the same time, the measure could, under certain conditions, create a two-tier market, with bonds not covered by the new regime worth more.

In 2003 the G10 made CACs the norm for most emerging market bonds issued under international law.   Continued...