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If Greece defaults – as many think it will – are your assets safe or will they slip through your grip faster than greased lightning?
Read on for a discussion of the risks of holding assets in Greece, Portugal, Ireland, Italy, and Spain, and what you can do to protect your fund from unnecessary additional risk.
A short history of weak Euro zone markets – a Greek perspective
- After becoming the 12th member of the Euro in 2001, the Greek government went on a spending spree, the good times rolled, and public borrowing soared. Events like the 2004 Olympic games in Athens didn’t help. The economy grew at more than 4% per annum for most of the 2000s. However, when the music stopped and the global financial crisis really started to bite, Greece was left with a huge deficit, far higher than the Eurozone rules permit: according to the Maastricht Treaty, countries are not supposed to run deficits higher than 3% of GDP. In July 2011, Bloomberg estimated that Greece’s central government deficit was 28% in the first half of 2011.[1]
- In 2009, Greece’s credit rating was downgraded for the first time by Fitch to BBB+ with a negative outlook amid fears the government could default on its ballooning debt. In April/May 2010, fears of a possible default on Greece's debts prompted Eurozone leaders to approve a €110bn rescue package for the country in conjunction with the IMF. In February of this year, international lenders then stated that the austerity measures so far implemented do not go far enough, further measures should be implemented, and Greece must speed up reforms to get its finances back on track.
- Standard & Poor’s Ratings Services (S&P) lowered its long-term sovereign credit ratings on the Hellenic Republic (Greece) to CCC: just four notches away from D, signifying default. The ratings agency branded the nation the lowest rated country in the world.
- Much of the nation’s infrastructure ground to a halt when the two biggest labour unions went on strike in opposition to Prime Minister George Papandreou’s additional fiscal cuts. Although the government initially failed to implement tough new austerity measures of budget cuts and asset sales, a subsequent vote saw the government’s €28bn austerity package narrowly approved, necessary to secure the next international financial aid instalment of €12bn. However, a further bailout of up to €150bn is still needed, and default is still a distinct possibility.
- German and French banks are believed to be the most exposed to the Greek debt crisis (other than the Greek banks) with €30 billion and €50 billion of exposures according to some industry observers, and they have been obliged to come to an outline agreement to roll over their holdings of maturing Greek bonds as part of a wider European plan to avoid sovereign default. However, Standard and Poor’s has stated it would call this a ‘selective default’, and if it goes ahead the European Central Bank would likely have to cease accepting Greek collateral, threatening the whole Greek banking system.
- If a full Greek default occurred, it would create immediate pressure on Irish, Italian and Portuguese sovereign and bank risks, potentially leading to a wave of defaults that would severely affect the Eurozone. Ireland’s rating has been consistently downgraded and now stands at BBB+ by Standard and Poor’s while Portugal has been downgraded to BBB-. Contagion risks would intensify around Europe and lead to an extended period of severe bank and sovereign risk aversion which could cause credit and liquidity to dry up. This would have a significant impact on many of the domestic banks who have already been weakened by domestic real-estate problems and who have been struggling to boost solvency to withstand just such a scenario.
What are the Risks of Defaulting Euro Markets to your Fund?
Realistically speaking, your investment managers will (should) probably already have reduced the fund’s direct exposure to Greece and the other periphery Eurozone markets well in advance of any default, however there are still some other considerations to ensure your fund and its assets are fully protected in the event of a Greek default and possible contagion across Europe.
A Thomas Murray contingency plan typically looks at three levels:
Global Custodian Risk
- The primary concern should be the custodian’s own exposure to the potential crisis. It is important to identify what is the custodian’s own exposure to the Portuguese, Irish, Italian, Greek, and Spanish markets either as holders of the country’s sovereign debt, as lenders to private companies, or as domestic retail or commercial banks. For example, it has been widely reported that BNP Paribas is estimated to have more than €5 billion[2] of exposure to Greek Sovereign debt alone. Your custodian should already have a press release available for clients.
- Many custodian banks make up part of the audience nervously looking on as this potential Greek tragedy unfolds across the Eurozone, particularly the European ‘universal’ banks who stand to lose far more than the Trust banks who appear to be less exposed.
Sub-custodian Risk
- The major agent banks in Greece are Bank of Cyprus, BNP Paribas, Citigroup, Eurobank EFG, HSBC, National Bank of Greece, Société Générale and UniCredit: your fund’s global custodian will be using one of these providers as their local agent.
- In Greece, Greek banks are the most exposed to their country’s debt and therefore present a very real counterparty risk to both the custodian and the eventual beneficial owner in the event of a default by Greece. A similar story occurs in the other markets, where the local providers are the most exposed to the somewhat precarious sovereign debt, and unfortunately many of these local providers may also act as sub-custodian to your global custodian in that particular market.
- Contingency arrangements should be in place and have been tested by your custodian with another (shadow) provider in each of these markets. Ask them to share details of these contingency arrangements with you, including the name and credit rating of both the current sub-custodian and the contingency provider. The custodian should already have agreements signed and an account open at the contingency provider with assets in the account. This should also be verified as it would prevent any delay in the event of having to switch to the contingency provider.
- The key question is how are your assets registered: are they in the sub-custodians’ nominees’ names? If so, you should take a view on your level of comfort with this arrangement (dependent on the sub-custodian) and whether it offers the fund the necessary level of protection in the event that the provider gets into difficulty. Greece is a beneficial owner market for equities: asset owners should ensure their fund is taking advantage of this and ensure that assets are indeed registered in the beneficial owner name at the sub-custodian.
- In addition, ask your custodian to confirm the local currency cash account structure at the sub-custodian, and whether cash is on or off book. In addition, information on the cash correspondent bank,[3] where applicable, should also be obtained. Cash only needs to be available on settlement date, and therefore can be kept off book until that point as there is no pre-funding requirement in the Greek market.
Check who your global custodian uses as sub-custodian in Greece!
Central Securities Depository Risk
We have focussed on Greece in this section. However, many of the questions are pertinent to other weak markets like Portugal, Ireland, Italy and Spain.
- In Greece, HELEX SA is the CSD for dematerialised equities and Bank of Greece is the CSD for government debt securities.
- Equities market: there is no legal basis for ‘nominee’ ownership in Greek law for equities, and records of ownership at HELEX SA are deemed to signify the legal and beneficial owner. Greece is therefore a beneficial owner (‘direct holding’) market. In other words, if the local sub-custodian is the ‘owner’ of these securities at the CSD (i.e. if they are not registered in your name) and it becomes bankrupt, can their liquidator then seize your assets? Some custodians may still hold client assets in omnibus accounts in the CSD's records. Law 3371/2005 on Capital Market Issues (effective 19th July 2005) sets the legislative framework for several issues with respect to the capital markets. One of the most significant changes relates to the legal aspect and results of liquidation proceedings of brokerage and investment firms and any seizure of clients’ assets held in the name of these firms. In summary, it provides that omnibus accounts do not have the adverse legal effects encountered under the previous law, in the event of insolvency of the holder of the account. This law seemed to open up the possibility for re-introducing omnibus accounts in Greece but this is yet to be introduced as market practice – double-check with your custodian.
- Commercial law in Greece links the recoverability of equities to the clear segregation of assets in full from the sub-custodian and their clients. If your fund does have exposure to Greece you should therefore confirm that your securities are not being in held in an omnibus account at the CSD in the sub-custodian’s name. The implications could be that your fund’s assets become encumbered unnecessarily in the event of sub-custodian insolvency or the insolvency of another client.
- Each account at HELEX is assigned a SAT code.[4] The SAT code comprises two 11-digit numbers representing a depository account number and a number which specifically identifies the underlying investor within the depository system. An easy test to ensure that your assets are indeed fully segregated at HELEX would be to ask your custodian for your unique SAT code to verify that your fund is recognised at the CSD level.
- Bonds market: apart from the obvious risks of default on Greek debt holdings, the safekeeping model for Greek debt differs in that the nominee concept is recognised and participants are required to hold the assets of their clients in omnibus accounts by client domicile (i.e. Greek, EU, non-EU). Participants may only open segregated accounts for clients who are direct members in a local bond trading platform (i.e. HDAT, MTS, BrokerTec).
Summary
Whilst it is unclear what the impact of a Greek default will be on the Eurozone and wider global economies, it is important that the potential risks are identified early to ensure that any impact to your fund from an asset safety perspective is minimised. It is clear that measures are generally available to ring-fence your assets where they are in the form of equities held at HELEX CSD; the same arrangement is not available for debt securities at Bank of Greece, which need to be held in omnibus accounts.
[1] http://www.bloomberg.com/news/2011-07-11/greek-state-budget-deficit-widens-28-in-first-six-months-1-.html
[2] http://www.scribd.com/doc/58007053/Which-banks-are-most-exposed-to-Greek-sovereign-debt
[3] Correspondent banks are used by domestic banks in order to service transactions originating in foreign countries, and act as a domestic bank's agent abroad. This is done because the domestic bank may have limited access to foreign financial markets, and cannot service its client accounts without opening up a branch in another country. Read more: http://www.investopedia.com/terms/c/correspondent-bank.asp#ixzz1QeHzjWBQ.
[4] Apothetirio’s Systima Aulon Titlon (SAT) is the dematerialised securities clearance and settlement system
Stephen Merry, Managing Consultant, Investor Services
smerry@thomasmurray.com |
