Europe, IMF need to act soon to avoid contagion: IIF

By John O'Donnell

BRUSSELS | Tue Jul 12, 2011 1:07pm EDT

(Reuters) - Euro zone countries and the IMF need to show they can deliver a rescue plan for Greece, including a debt buyback, in coming days to avoid financial markets "spinning out of control," a bank lobby group said.

The Institute of International Finance (IIF), which is leading negotiations on behalf of banks and insurers with billions of euros of exposure to Greekbonds, made the warning in a draft paper delivered to European finance ministers, dated July 10 and seen by Reuters.

"It is essential that euro area member states and the IMF act in the coming days to avoid market developments spinning out of control and risk contagion accelerating," the paper said.

That contagion risk has become even starker this week. Bank shares on Tuesday crashed to a two-year low on fears that Greece is heading for a disorderly default and that the debt crisis may spread to Italy, lifting its borrowing costs and the risk its debt pile could also be unsustainable.

A program to buy back Greek bonds is needed to significantly reduce its debt mountain and provide a sustainable long-term platform and prevent it calling on taxpayer help again in the future, the IIF's paper said.

Greece could target the buyback of debt on a voluntary basis, through open market purchases, special tenders or negotiated deals with individual investors. It would take advantage of big discounts in secondary markets of over 50 percent on long-dated Greek paper.

The IIF said the options it outlined, if implemented on a voluntary basis, would not trigger a credit event as defined by ISDA, the group that has the final say on the issue.

The lobby group also warned the release of stress test results for 91 banks due on Friday "may exacerbate market concerns about potential losses on other euro area sovereign bonds."

PLAN B? OR C?

Creditors are attempting to fine-tune a voluntary private-sector creditor’s deal for Greece that can get past credit rating agencies without it being termed a default.

Banking industry sources have said finding a solution will take some time, but a lack of progress has raised doubts they will agree a plan to contribute 30 billion euros to the rescue.

The debt buyback is one of a trio of options private sector creditors are discussing under the IIF.

A French proposal for bondholders to reinvest at least 70 percent of the proceeds from bonds maturing between now and the end of 2014 in new 30-year Greek debt has lost momentum since it surfaced two weeks ago and is seen as less likely to work.

An alternative that would reduce the principal value of Greek debt is also being considered. Investors would need to accept a reduction in the principal value of their debt, but would receive a better interest rate and a shorter maturity, of 10-30 years.

Offering multiple options would attract more private sector involvement. The IIF said well structured credit enhancements, perhaps targeting about 180 billion euros of bonds maturing by 2019, could allow private investors to remain engaged in Greece in the long term.