Why it could pay hedge funds to force a Greek default

GREECE and its private creditors are attempting to hammer out an agreement which would write off 50 per cent of the country's debts. The deal for the creditors to take a so-called 'haircut' must be struck before the EU, IMF and ECB hand Greece further bailout funds of €130bn. Athens needs this money by 20 March, when it must repay loans worth €14.5bn.

WHAT IF THERE IS NO DEAL?

The consequences could be ruinous for European economies and the wider world. Greece would have the opportunity to decide for itself what it was prepared to pay its creditors, which could be nothing at all. This might lead to further defaults among the other weak eurozone nations such as Portugal and Ireland.

Nobody would want such a 'disorderly default' to happen – would they?

WHO MIGHT PROFIT FROM A GREEK DEFAULT?

Some of Greece's creditors are hedge funds which were buying up Greek debt on the cheap in December, because they thought a default would not happen before the 20 March repayment deadline and they would get all their money back.

That is now looking like a foolhardy bet – but fund managers believe they can still clean up if they force a default by refusing to accept a 50 per cent debt haircut.

HOW WOULD THE HEDGE FUNDS WIN?

Bloomberg reports: "Some fund managers say they have little incentive to accept the [haircut], and are seeking full payment." If Greece refuses to pay what it owes, the funds can trigger the insurance they took out on the Greek debt, so-called 'credit-default swaps' (CDSs), and receive the full amount from the insurers.

WHAT WOULD HAPPEN THEN?

A financial crisis worse than that of 2008, says business magazine Inc. The hedge funds' plan is based on the idea that the insurers have the money to pay off CDSs. "They don't. They have some money and a lot of loans out on bonds and properties of questionable value from other European banks. They will have to call in those loans in order to pay off the CDSs. This will require other banks to call in loans and sell assets in order to pay what they owe."

CAN THE HEDGE FUNDS BE STOPPED?

Gabriel Sterne, economist from Exotix, told the BBC's Today programme this morning that "there is no doubt that Greece needs to introduce legislation to force [hedge funds] to join in" the voluntary haircut. This would prevent the hedge funds from forcing a disorderly default - although a default could still happen by some other means.

WILL HEDGE FUNDS TAKE THIS LYING DOWN?

Probably not. Hedge funds might mount a legal challenge at the European Court of Human Rights against being forced to take a haircut on the basis of their human rights – specifically that they will have been deprived of their property without due process and compensation.

A partner at a top London law firm told the Financial Times that such a challenge would take "years" and is "in the realm of fantasy football". ·