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* Restructuring experts question 70% buying threshold
* State aid rules could create unintended issues
* Selling may be the only answer
By Robert Smith
LONDON, June 8 (IFR) - The European Central Bank began buying corporate bonds on Wednesday in a move to spur the economy, but it could open up unprecedented conflict if the bank ends up holding large stakes in the debt of companies that need to restructure.
Early indications are that it is buying five-year utility bonds in secondary markets, according to market sources.
The ECB is targeting seemingly safe, investment-grade companies but these have seen spikes in defaults in the past, particularly when industry cycles have suddenly turned.
While there were no investment-grade defaults during 2012-2015, according to S&P data, there were a number during the telecoms bust of the early 2000s, with 13 investment-grade defaults in 2002 alone.
Several market sources said that they did not think the ECB had given much thought to the issue, given buoyant conditions in corporate credit and low default rates across Europe.
And individual companies previously thought rock solid can be hit by “black swan” events, such as when investment-grade rated Parmalat’s management was revealed to have committed fraud in 2003, resulting in Europe’s biggest bankruptcy.
In these instances, the ECB would be on uncertain ground, particularly given that EU state aid laws could be invoked if a national central bank forgave debt in a restructuring.
“You don’t even have to go that far to imagine potential issues the programme creates,” said Kai Andreas Schaffelhuber, a partner at Allen & Overy in Frankfurt.
“If a central bank purchased large amounts of a large manufacturer’s debt, improving its refinancing conditions and giving it a shot in the arm, could that constitute a distortion of competition versus another company that hasn’t benefited from any bond purchases?”
National central banks will publish a list of corporate bond ISINs they have purchased on a weekly basis, making these debates a real prospect, though they will not disclose the amounts held of each bond.
“Now it will be easier to associate the ECB with issuers, or sectors, that have troubled credit quality, or worse - suffer idiosyncratic risk down the line,” said Bank of America Merrill Lynch credit strategists in a note last week, adding that the transparency has the potential “to create reputational problems for the ECB”.
SOVEREIGN LIMITS
In the sovereign debt market, the ECB places strict limits on the percentage of each bond it can buy, in order to avoid becoming a “dominant creditor”. The central bank limits its purchases to 25% of bonds with collective action clauses (CACs) to avoid obtaining a blocking minority, for example.
But while the ECB has legal limits on providing debt relief to governments, there are no laws governing its role in a corporate debt restructuring. This flexibility has allowed it to set a generous 70% upper limit for holdings of each corporate bond.
“It’s very hard to dispel the impression that it’s a bail-out if the ECB were to acquire as much as 70% of a company’s debt,” said Richard Nevins, a partner in Cadwalader, Wickersham & Taft’s London financial restructuring group
“And the central bank would not want to take an active role in any restructuring, as voting for a plan that sacked a lot of workers in a member state would be so politically unpalatable.”
This could create a Catch-22 situation for the ECB if it becomes a major bondholder in a restructuring, as market sources said that even if it did not want to take an active role, taking a back seat could hamper negotiations.
“Sovereign bonds now pretty much all have CACs in them, but corporate bonds typically don’t have multi-series CACs,” said Arjun Muddu, a counsel in Linklaters’ capital markets team. “So restructuring a series of bonds where a 70% holder did not participate may be very difficult.”
SELL! SELL! SELL!
Several restructuring lawyers said that the least-worst option available to the ECB if a company got into trouble would be to sell its bonds.
Some in the market have expressed concerns around the potential for market dislocation such selling could create, leading the ECB to clarify last week that it would not become a forced seller if a company lost its investment-grade rating.
But even if the ECB did sell, Kon Asimacopoulos, a partner in the restructuring group at Kirkland & Ellis, pointed out that you already routinely have stressed or distressed situations where investment-grade holders sell bonds the moment the credit deteriorates.
“And there are numerous distressed debt buyers who would be prepared to buy large chunks of paper from a single holder which might allow them to control a restructuring.”
Selling to distressed buyers could of course generate negative publicity for the central bank, if they then took aggressive measures against a company.
But Andrew Wilkinson, a partner in Weil, Gotshal & Manges’ restructuring group said he thought selling was the only real option available to the ECB if things came to a head.
“If they are involved in a situation heading towards restructuring, they’d just have to sell,” he said.
“We know what the ECB being dragged into a debt restructuring looks like from Greece - it becomes acutely political.” (Reporting by Robert Smith; editing by Alex Chambers, Sudip Roy)