The ESM Treaty and PSI

There is some discussion of this issue in the comments but it’s worth putting on the front page. A much-heralded part of December’s EU negotiations was the decision to change the language on Private Sector Involvement (PSI) in the ESM Treaty.

On December 9, Herman van Rumpoy said

our first approach to PSI, which had a very negative effect on debt markets is now officially over.

It was being replaced with the following

from now on we will strictly adhere to the IMF principles and practices

Sure enough, the new ESM Treaty states

In accordance with IMF practice, in exceptional cases an adequate and proportionate form of private sector involvement shall be considered in cases where stability support is provided accompanied by conditionality in the form of a macro-economic adjustment programme.

Some are arguing that this is effectively a commitment to limit PSI to Greece. I don’t see how this is a tenable assumption. As this FT Alphaville post discusses, there is no sense in which IMF procedures rule out PSI. Furthermore, bond markets are also clearly not interpreting the new ESM treaty in this fashion since Portuguese bond yields are still effectively pricing in a default.

It’s very hard to see how, if the stars end up aligning sufficiently badly for Ireland, that “an adequate and proportionate” haircut won’t get applied to private sovereign bond holders.

45 replies on “The ESM Treaty and PSI”

Global Debt Crisis

The greatest private fraud of human history.
Who are the great fraudsters who are becoming the murderers of the human kind? How does the economy “illness” threaten Democracy and the freedom of people?
By knowing what happened in indebted Greece, where loan sharks created “bubbles” and the current inhuman debt, one can understand the inhuman plan in total …understand where this plan started just to bring all states at the same end …understand how this type of plans are established…


@ Karl

the updated ESM treaty does not rule out PSI, but it does reduce down the chances of it occurring. Specifically it now allows the ESM to buy bonds freely (as opposed to previous “exceptional” basis) on the primary and secondary markets, and, perhaps crucially, providing “precautionary conditioned credit lines” as well as a full on loan. So financial assistance may arrive in a precautionary ESM-lite credit line and bond purchases, thus allowing a country to stay in the markets or use as a top up to market funding.

@Bond Eoin Bond

“Specifically it now allows the ESM to buy bonds freely”

Does that mean the ECB will stop its bond buying programme when the ESM is up and running?

Might it also mean that the ESM will end up blowing all it’s money on bond buying over a period of time and when that doesn’t work, have very little left to put up in the way of loans and financial assistance to those who need it after the bond buying didn’t work?

I’m sure there are a number of people who do want to see PSI limited to Greece (not that it actually has been yet – but no doubt a deal is still only ‘hours away’) but it’s difficult to see how PSI can’t be left on the table…. taking it off is surely just equivalent to painting yourself into a corner?

@ PR Guy

should there be risk free assets in the world? Prof Lane believes there should be, and that there are not enough of them. Keeping PSI on the table only reduces down further the amount of risk free assets available.

“if the starts end up aligning sufficiently badly for Ireland”

should read

“if the stars dont end up aligning extraordinarily well for Ireland”

It seems to me that telling someone there will be no PSI is not the oppisite of telling someone that there will be PSI (well it doesnt have the same proportionate impact).

In the previous wording it was clear that private bondholders might have to take haircuts. Even if they were trying to say that there would absolutely no haircuts, its a bit like an election promise. It is totally unenforceable by the bondholders – if it was enforceable we would have Eurobonds.

Conditions for ESM entry can be changed at Merkels whim at any stage.

a) ” if the starts end up ”

“stars” surely

b) Of course it doesn’t rule out PSI. What is going on is that officialdom (and all the financial institutions who are long) are “saying whatever it takes” in terms of spin, to try to convince market players that there will be so much bond buying, precautionary credit lines, official loans and general can kicking, that taking a bearish investment stance on the bonds in question will take so long to pay off that you will have been sacked by your clients by the time it pays off.


there is no such thing as risk free assets in this world and they are impossible to construct.

almost risk free is possible but even then the unknowns unknowns should result in a requirement for a risk premium (to a rational investor).

Obviously banks, insurance companies etc have to invest at any price in what are deemed “risk free” assets

@Bond Eoin Bond

I get your drift but is anything really risk free? Ever? Anywhere? Even living isn’t, let alone investing. Maybe if you’ve got a good hedging operation behind your investment products, you can provide some form of guarantees to investors – but they will jolly well pay for it in charges and fees.

p.s. I also meant to ask: Greece just annnounced it would auction €625m of 6-month T-bills next Tuesday…. being in a programme, why does it need to hold this auction? Has the petty cash tin run out and the Troika doesn’t top up petty cash tins or something? i.e. is it to make up for a sudden shortfall somewhere or an emergency bill to be paid? I hope it’s not to pay for Iranian oil (that Greece receives via Egyptian ports)!!



The message is: don’t short us; if you do we’ll get you – sooner or later.

Why can’t people just accept that, with a lot of huffing and puffing, the EU’s Grand Panjandrums will get there eventually? And surely it’s not in the interests of many/(most?) sovereign bond market participants for the supply curve to shift in significantly? Won’t they need a home for ‘good money’ with a reasonable coupon?

Nothing to see here. Move along please.


I think many readers might get a bit confused about the fundamental concept of “risk free” assets. We should be able to agree on something like this:

You can make your bonds risk free in the sense that you say this:

“if it looks like we might not be able to honour these bonds, don’t forget that we can always just print you some new money and pay you with that – so all you are really risking is that the international value of the money we pay you might diminish a bit”

That is the Anglo-saxon approach. Anyone who has tried to forecast FX markets will understand why investors are not too bothered about that type of ‘risk’.

If the EZ and ECB are going to continue with the “hard money” act then unless you think the Germanication of EZ economnies over the next 5 years or so will actually happen, you are hard pressed to conclude the assets in question can be ‘talked’ into becoming ‘risk free’.

@ various re risk free

As Grumpy notes, a central bank in theory can eradicate “credit risk”, albeit whilst potentially creating an equally, if not more so, inflationary risk. But i get the point that nothing is truly, completely “risk free”. However, the world certainly needs ultra ultra low risk assets, and PSI only creates less of these assets (unless you view the EZ as a kinda tranched CDO), at least at the marginal level.

@ Pr Guy

they have tbill auctions all the time. Greek banks buy them, some Greek retail too. They are outside PSI. Nothing unusual in it. Portugal holds tbill auctions too, NTMA reopening ours in June/July.


The outcome is exactly as you describe. The compromise wording on IMF involvement is designed to save face for the party retreating from a previous hardline position; to wit, Germany.

It remains to be seen whether Berlin will call the bluff this weekend of the Greek PM in relation to the involvement of “official lenders”, i.e. the ECB and CB’s that have purchased Greek bonds, in the “unique” PSI effort for Greece.

Caught between a rock and a hard place!

Given the structure of the Greek economy, notably its enormous off-shore shipping industry and the inner track that this gives its financial and investor community, and the geo-political considerations that apply in the region, I would take a brave man to predict the outcome. The sum needed is now estimated at €15 billion.

Bundesbank has provided .5 trillion Euros so far in EU bailout, with graphs:

Portuguese bonds are not Greek bonds:

“Oops: negative pledge (a simple one at that, not that garbled monstrosity of verbiage that some Greek bonds have) and UK-law. Looks like the Greek Modus Operandi of dealing with its uber-leverage problems will be quite hindered (read impossible) when its comes to Portugal, where a substantial portion of its sovereign debt actually does have significant creditor protections. It also means good luck not only trying to enforce a coercive cram down, but also attempting to layer on a primed piece of debt with liens on top of the EMTNs (i.e. IMF bailout capital), without every asset manager in possession of these bonds suing the country into oblivion at a London court of law. ”

From a usually reliable journalist I know in Greece (he’s in his 60’s has good contacts and not given to wild speculation): PM Papademos is going to threaten Greek political leaders tomorrow that he will resign on Monday if they don’t sign up to Troika demands (min wage cut, 13/14th payment, PS job cuts, etc.) and the country will burn if he does. Greek political leaders say they don’t want to because it will damage their election prospects. Could be an interesting weekend in Athens.

Meanwhile, Venizelos in a speech this afternoon was giving it the ‘tough decisions need to be made that will be painful.’ I love the way it’s the guys who are never ever going to be affected by the decisions they make that are always giving it the crocodile tears and wringing their hands about being the ones who have to make the ‘tough decisions’ …. a laugh a minute.

@ Viator

Re the Telegraph article cited in the piece you linked to:

“The operations are part of the European Central Bank’s ‘TARGET2’ network of automatic payments between the national central banks of the Euroland club. The Bundesbank has already provided €496bn (£413bn) to countries in trouble, chiefly Greece, Ireland, Italy and Spain.

The Bundesbank – the dominant body in the euro system – used to keep a stock of €270bn of private securities (refinance credit) before the start of the financial crisis. This was depleted last year as it sold assets to meet growing demands on the TARGET2 scheme”

It might be worth noting that everything in those to paragraphs is pretty much completely wrong. See this piece for explanation

@ PR

It was reported in one of the Greek papers this morning, seems to be standard political “back me or sack me” rhetoric.

@ Viatoro

I believe the Zerohede article to be highly inaccurate – from a brief glance through Portiguese bond terms, most are covered by Portuguese law, only a small portion (their “international” bonds) are covered by UK law. Actually a similar situation to Greece. Ireland is actually somewhat in the minority by not really having any international bonds.

PSI will never be off the table while the IMF are co-funding the official support, no matter how many times the EU Heads of State whip out their “sovereign signature” pens. If things get bad enough the IMF will insist on restructuring, just as they did with Greece. The fantasy-land where a debt of over 200% of GDP can be brought back under control solely with “structural reforms” (as stated in the joint EU Commission/ECB report on Greece back in August) may extend to Brussels and Frankfurt, but does not extend to Washington, Tokyo and Beijing.

The European powers-that-be wanted to toy a bit with PSI and found in Greece the perfect candidate for their Frankenstein-style experiment. To the surprise of absolutely everyone, it has proven to be a complete disaster.

Our super-smart European powers-that-be have thought a bit longer about PSI, and have probably understood that the next candidates for their experiments, Ireland and Portugal, might well refuse to go through this ordeal.

They are more likely to leave the Euro in a hurry, rule out any kind of default, and get their central banks to make that sure. And just to emphasise the point that they really do not want to default on private bondholders, they might default instead on the official debt holders, despite their demonstrated crisis enhancement capabilities.

Furthermore, there is a real danger, as seen from the point of view of the so benevolent European powers-that-be, that Ireland and Portugal might quickly recover access to the bond markets on exit from the Euro. And this probably without much depreciation of their reborn currencies, as these countries have already delivered on the hardest part of their macro-economic adjustment.

In such a nightmare scenario, the oh so illuminating European powers-that-be might fear that a very large number of other Euro countries (Cyprus, Slovenia, Spain, Italy, Belgium, France, etc) might follow the very bad examples of Ireland and Portugal and also decide to escape their clutches.

Hands up who agrees with the Jim Power style argument that Money & Politics don’t mix ?
What a absurd argument – Money is Politics & Politics is Money.


“there is a real danger, as seen from the point of view of the so benevolent European powers-that-be, that Ireland and Portugal might quickly recover access to the bond markets”
Argentina has not done that yet,why would it be different this time?

A massive devaluation would collapse the standard of living like it did in Argentina and Iceland ,do you wish that?

Tell me why the currency of a country with a current account surplus would necessarily have to depreciate massively. Ireland has a small current account surplus since 2010. Portugal still has a current account deficit, but it is falling very rapidly. I bet on a current account surplus in 2012.

Tell me why government bond yields of countries where the private sector is rapidly deleveraging would be high, if you have your own currency and your own central bank. Look at Japan. Look at the US. Look at the UK. A current account surplus and a large budget deficit can only occur if the private sector is deleveraging rapidly. A lose monetary policy will not be inflationary in such circumstances.

@Karl Whelan – point of order – the chap’s name is Van Rompuy, not Rumpoy. Not that I’ve heard a newsreader or journo pronounce it correctly to date.

@ Incognito

Tell me why the currency of a country with a current account surplus would necessarily have to depreciate massively. Ireland has a small current account surplus since 2010.

Most of the Irish trade surplus is accumulated in US dollars and remains in US dollars; if it is not being used for inter-company funding, it resides in US bank accounts or maybe invested in US Treasuries – – even though it is sometimes claimed that such funds are ‘trapped’ overseas.

A new cuurency would hardly be in demand by overseas investors.

€15bn of indigenous exports net of imported material wouldn’t support much consumer imports of goods and services.

Karl Whelan’s interpretation sounds good to me.
Starting to read through this ESM treaty this morning.
It seems to me that :
“an adequate and proportionate form of private sector involvement shall be considered” is what it says on the tin.
But who does the considering? The Board of the ESM?

The Legal position if PSI occured:
I would like to pose the following question. If Irish State bondholders suffer losses (PSI) at some point, which as most people agree is principally because of the imposition of bank debt, would bondholders have a legal case for compensation from the State or from the ECB who insisted that these debts be taken on and paid by the State. Debts which were extraneous to the State and did not exist to the State at the time the State bonds were originally issued.

“Anschluss Economics – The Germans Launch A Blitzkrieg on the Greek Debt Negotiations” by Marshall Auerback

But there’s another, more sinister interpretation. The question which has been persistently asked since the debt renegotiations started with Greece is: what will stop Portugal, Ireland, or indeed Spain from demanding the same deal? And I continue to believe that Spain is the domino which is too big to fail. Its liabilities are too big to be covered by the existing firewall established by the EFSF and ESM. An expansion of the LTRO might address the solvency/banking crisis, but not the broader problem of deficit aggregate demand, high unemployment, and rising social turmoil.

So to repeat the question: how do you preclude Portugal, Ireland and, indeed, Spain from asking for the same deal as Greece, if the negotiations succeed?
Answer; you can’t. So the Germans throw a politically impossible demand in front of the Greeks, in effect saying, “No more money unless you effectively surrender your national sovereignty.” And that’s the implied warning ahead for the other periphery countries which look to secure the deal currently on the table for Greece.
In effect, the Germans (behind the auspices of the troika) are saying, “It’s fiscal austerity on our terms. You try to renegotiate like the Greeks and we take you over. The other alternative is that you leave.”.

Anschluss economics, plain and simple.
Is this too harsh an assessment? Well, when their national interests are at stake, the Germans are perfectly prepared to shed the “good European” persona and play hardball. Think back to how the Bundesbank engineered the departure of Britain from the ERM back in the early 1990s, and you’ve got the template for today. By publicly suggesting that sterling was overvalued and refusing to offer support to the British pound (in contrast to its subsequent defence of the French franc), then BUBA President Helmut Schlesinger virtually assured the UK’s ejection from the Exchange Rate Mechanism. Let’s face it: history shows that Germany doesn’t do “subtle” very well. This looks like a blitzkrieg, plain and simple. Spain, Ireland, Portugal and Italy – you have been warned.

@ Viator

The article you link to claims that 62% of periphery bonds are issued under “international” rather than “domestic” law. It gets this claim from a ZH article which says that 37bn of Irelands 91bn of notional bond issuance is issued under international law. Having just gone through every offering circular on the NTMA website, I can tell you this is COMPLETE horsesh1t. Every Irish bond has been issued under “Irish” law. Please check it out yourself.

Given that ZH has gotten the Irish figures absolutely and completely wrong, it is fair to question some of his other figures, notwithstanding that there is a good bit of “international” issuance from Italy from recollection. I do not recall there being very much Spanish or Portuguese “international” issuance.

The source is here which includes zerohedge and Bloomberg. (also includes a rundown on zerohedge)

Here is another article from zerohedge. Included is a screen shot from Bloomberg.

“Away from Portugal, the differentiation between local and non-local law bonds is increasing with Italy, Spain, Greece, and Ireland all showing Non-local law bonds trading at significant premia to local-law now.”

If EU non-local bonds are being traded and displayed on Bloomberg terminals then they certainly exist.

@ Viator

…or ZH is just getting it wrong, which, trust me, happens on occasion. Go to the NTMA web link above, check out the offering circular, look at the “legal jurisdiction” section. It quite clearly says “IRELAND”. Zero Hedge uses himself as a reference, don’t think you’re really supposed to do that if you want people to believe you…

Here is the original article from zerohedge with references:

“Based on Bloomberg data (using the GOVERNING_LAW mnemonic) in which clearly defined local law bonds are segregated from NA or non-local ones, the sovereign debt universe of the PIIGS, which amounts to €2.1 trillion, consists of €1.3 trillion in non-local law bonds, and a whopping €800 billion in local law bonds!”

“While not disclosing them here publicly, Zero Hedge is happy to discuss with its readers the CUSIP list of these two distinct bond sets. Because while quite a bit, if not nearly enough, has been said in the media about the two bond indenture classes in Greek bonds, absolutely nothing has been discussed about how this problem extends into the general periphery. Here, for the first time, we present it visually, by showing a matrix of bond price vs years to maturity for all five PIIGS. As expected, and as confirmed by the Choi and Gulati analysis, bonds with stronger protection (i.e. issued under non-local law) trade broadly richer than those without protection.”

“What is also known, is that the historical track record confirms that sovereign default litigation is not only not futile, but as already noted is among the most lucrative transaction types known to the buyside. ”

@ Viator

International bonds have a different ticker to domestic bonds, for Ireland it’s IRISH (Dom) vs IRELND (Intl), GGB vs GREECE, BTPS vs ITALY etc. I just checked on Bloomberg – there are IRELND bonds currently outstanding. The CP programme is probably covered by international issuance, but is relatively minimal and short term issuance is not included in PSI in any case. As I said, ZH is completely wrong on this issue.

Last Monday Bloomberg carried a short piece with an invited analyst around 6.00 pm (CET) where she positioned Ireland as next to succumb after Greece. Did it get any coverage in Ireland?

My question really is this: how could Ireland insist on private sector discounting with the insane bank guarantee in place? The same guarantee that allegedly underpins ECB continuing support.

If someone could post a suggestion has to how all this can be unpicked, I would be grateful.

@ Viator

You’ve posted an enormous amount of data there, without detailing what i should be looking for, and so which at a cursory glance seems to deal with how bond default negotiations work, rather than the concrete data detailing local vs international jurisdiction underlying the sovereign debt in question. So I’m not sure what ur point is?

Secondly, ZH says “While not disclosing them here publicly, Zero Hedge is happy to discuss with its readers the CUSIP list of these two distinct bond sets.” – Does that not strike you as an odd suggestion, that somehow this list is kinda secret or something, despite it apparently also being at the same time available on Bloomberg, and despite ZH never usually beig shy to publish information? I’ll say it only one last time – going from the NTMA website, and the standard ticker difference for international vs domestic bond issuance, Ireland does not have any international bond issuance great than the few hundred million in CP and ONE legacy JPY bond worth a couple of hundred million Euro (and whcih may not even exist anymore). Further, I am sceptical that Spain has the majority of its debt governed by international law, but will take a full look on Monday. I further believe from having looked when the original ZH article was published which dealt with Portugal international debt that the 25% grossly overstates the real situation. Posting links to ZH alone will not convince anyone.

Why should I give my humble opinion when there are numerous far more informed commentators that can be brought to the discussion?

As for the links, a number of people said zerohedge was wrong, others said they didn’t know what they are talking about.

Those links above contain some of the best legal, official and academic opinions on the topic under discussion, mostly PDFs. I would expect some people might be grateful for the references.

A little investigation, and some reading above, reveals that zerohedge, a nom de plume, is conduit for some of the more informed, but anonymous, commentary extant on the web. It is anti-establishment, somewhat libertarian, and seems to me composed of financial professionals who are fed up with the status quo, lies, dogma and other garbage which has brought us all to the place we find ourselves presently.

In any case I posit they have certainly made the case there are two classes of EU bonds, local and non-local, including Irish bonds, with far reaching implications for the future.

@ Viator

“In any case I posit they have certainly made the case there are two classes of EU bonds, local and non-local, including Irish bonds, with far reaching implications for the future.”

A case? A claim? Yes. But one which does not stand up to scrutiny when you look at official documentation.

Has the deadline for setting a new deadline in Greece been set yet?
I wonder where all that money came from that’s been flooding into Julius Baer over the past year?

The party leaders are due to meet with Papademos again to finalise and seal their agreements, which of course must conform to the demands of the troika.

“Preliminary agreement with the stamp of party leaders” read Ethnos’ headline, which outlined the points of agreement. The question is whether the leaders can impose party discipline in passing all the measures of the new memorandum, such as the troika’s demand for 15,000 civil service sackings by Easter.

“Near agreement: What we sacrifice, what we salvage” declared Ta Nea’s headline. The paper reported that the troika wants a 20 percent cut in the minimum wage and a 35 percent cut in auxiliary pensions, whereas the government wants only a 15 percent cut in pensions.

“The holiday bonuses are saved” declared Eleftheros Typos’ headline, which also reported on the party leaders’ agreement. The paper reported that the new minimum wage in Greece will be between that in Spain and that of Portugal. It also reported that party leaders put a “brake” on the troika’s demand for an increase in the tax valuation of real estate.”

No info yet on PSI

@Colm Brazel – the data on the Guardian link is neither complete nor recent. It’s drawn from one of the earlier EBA stress tests, and covers just European banks – not US or any other banks that may hold exposure. It’s not inaccurate per se, just incomplete and out-of-date.

@aiman Oh I think we can say it is inaccurate given that post EBA stress tests we’ve had both Dexia and DB mention how they were being “muscled” into holding onto GGBs, and being involved in PSI. 70% NPV ain’t voluntary whichever way you cut it, if there was the slightest whiff that the 50% “agreed” in the autumn actually translated to well in excess of 50% NPV then any rational bank would have divested at that price as quickly as possible, and any rational Government would have desisted from applying further “moral suasion” to banks on their watch, who they (and their taxpayers) implicitly underwrote!

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