Greek financial crisis – what next?
Greece is facing a severe liquidity crunch with a rapid deterioration in the Government's cash position. This is evidenced by the Greek Government's recent request for wider public sector entities and local authorities to deposit their available cash with the Bank of Greece, for embassies to repatriate available funds to Greece and for the liquidation and consolidation of a number of State entities. Suppliers are not being paid, VAT is not being refunded on time and even hospital expenditure has allegedly being cut by 50%. So far the Government is honouring its salary and wage obligations to the wider public sector employees, as well as its payments and contributions to pension funds. It is also honouring financial debt obligations. However, major principal payments of debt are due in June, July and August 2015 and the Government has conceded that, without further loans from the International Monetary Fund (IMF) and the European Financial Stability Facility (EFSF), it may default on these payments. In its effort to raise funds, the Greek Government has turned to the Greek banks. These have provided some funds by subscribing to Greek Treasury Bills. Nonetheless, the Single Supervisory Mechanism of the European Central Bank (ECB) which now supervises Greek banks has set ceilings on the amounts of such T-Bills which can be held by Greek banks. Even though these ceilings have protected their liquidity position, this has not alleviated their liquidity pressures which continue from the withdrawal of deposits either by entities required to do so by Greece or by anxious depositors.
As a result, the Greek banks are also in a liquidity crisis. With the wholesale markets closed to them and with depositor unrest, Greek banks have been relying, for the liquidity, on (i) some of the ECB's facilities (to the extent of eligible collateral, eg through the targeted longer-term refinancing operations (TLTROs) facility) and (ii) increasingly on the Emergency Liquidity Assistance (ELA) for life support. ELA is exceptional funding provided not under the ECB's usual direct refinancing operations but rather by the relevant national central bank. Collateral is required for ELA funding, though the quality requirements are looser than for the ECB's facilities with the relevant haircut being higher. Greek Government assets are not eligible for usual direct refinancing operations with the ECB as they lack the requisite credit rating. A waiver of the rating requirement is possible (and has been granted in the past) but this requires the implementation of the bailout programme.
ELA is provided "to a solvent financial institution, or group of solvent financial institutions, facing temporary liquidity problems, without such operation being part of the single monetary policy… Article 14.4 of the Statute of the European System of Central Banks and of the European Central Bank (Statute of the ESCB) assigns the Governing Council of the ECB responsibility for restricting ELA operations if it considers that these operations interfere with the objectives and tasks of the Eurosystem. Such decisions are taken by the Governing Council with a majority of two-thirds of the votes cast."1
The Governing Council has imposed limits on the overall volume of ELA operations envisaged for the Greek banks. These limits are reviewed on a weekly basis and have been incrementally increased by the ECB over time. However, Greek banks face two challenges in order to be able to continue receiving ELA:
(i) they must be able to continue providing collateral in exchange for ELA; and
(ii) they must continue to qualify as solvent financial institutions.
Greek banks were recently re-capitalised and deemed "fit and healthy" by the ECB. However, given the continuing flight of funds they may struggle to continue providing adequate collateral for the ELA, and if the Hellenic Republic defaults on any of its imminent payments to the ECB and the IMF (due in June, July and August 2015 – see the timetable of future payments below). In such circumstances the Greek Government may be forced to consider imposing capital controls and taking other measures to protect the banking system. It is not inconceivable that the ECB may reconsider whether the Greek banks meet the requirements to qualify for ELA, though doing so would turn the ECB into the arbiter of Eurozone membership, a role which is not constitutionally appropriate for it.
To the extent that the Greek economy continues to deteriorate, Greek banks may also face pressures on their capital as the incidence of non-performing loans increases and as deferred tax credits are eroded by the absence of future taxable profits.
Capital controls will not be imposed lightly. They contravene one of the key freedoms on which the European architecture has been built: freedom of capital. If imposed, they are likely to stay in place for some time, thereby inhibiting future growth. They are also perceived to be risky for the political future of those who will advocate and introduce them.
If capital controls are to be imposed then, as in Cyprus, the first step taken by the Hellenic Republic may be to declare temporary bank holidays and shut the banks for a few days (or even weeks). Following the re-opening of the banks, capital controls may be put in place to restrict withdrawals and transfers abroad.
Capital controls are measures undertaken to regulate or limit the flow of capital into, and/or out of, the domestic economy. There is no generally accepted definition, but strictly speaking they are distinguished from measures which regulate current transactions, such as payments in connection with foreign trade and business, services including short-term banking facilities and the payments of interest or income generated from capital investments. Controls on current payments may also be imposed.
Although EU Member States are bound by the general prohibition on restrictions on the movement of payments and capital between EU Member States and between EU Member States and third countries (Article 63 of the Treaty on the functioning of the European Union (TFEU)), the TFEU provides for a number of exceptions. One of the exceptions is that each Member State has the right to "take measures which are justified on the grounds of public policy or public security" (Article 65(1) of TFEU). These measures may not, however, constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital and payments (Article 65(3)). The ECJ has sought to emphasise the limited scope of this exception, providing that there must be "a genuine and sufficiently serious threat to a fundamental interest of society", as well as compliance with the principles of non-discrimination and proportionality.
Why might the legality of any controls imposed by Greece matter to commercial parties? There are a number of reasons finance parties may be concerned about such issues.
Any breach of such controls is likely to be a criminal offence in Greece. Parties with any presence in, or nexus to, Greece will need to take particular care in this regard. In circumstances where there may be ambiguity as to whether particular payments are permitted by the relevant controls, the risk of taking a view and making a payment when a criminal sanction may result is a potentially significant one.
Parties may need to assess, on an individual, deal-by-deal, basis, whether any payments due under a contract are permitted by the controls and whether any special authorisations or permissions are required. If payments are not permitted, parties will need to assess whether non-payment might be considered a breach of contract under the relevant applicable law. Such an analysis will be time consuming and legally complex.
The assessment of an English court as to whether any controls are in compliance with the EU Treaties (see above) may well have an impact on the extent to which the court will have regard to Greek law when considering disputes under English law contracts. It may impact the extent to which:
(i) the English court would give effect or have regard to Greek law in a contract governed by an external law, such as English law. In such a case the English court is more likely to give effect to Greek law if Greek law is deemed to accord with (or not be in breach of) the Treaties; and
(ii) any Greek law is found to be inapplicable on the basis that it is contrary to English public policy. Again in such a case, it is less likely that the English court would find that it would be contrary to public policy to apply Greek law, if the Greek law is deemed to accord with or not be in breach of the Treaties.
Cyprus, a Member State, relied on the Article 65 exception when it introduced capital controls in 2013. The relevant decree expressly referenced the need to introduce controls to safeguard "public order and public security and for overriding reasons of public interest" echoing the language of the Treaties.
In its statement of 28 March 2013, the European Commission noted that controls had been imposed in Cyprus and that the stability of financial markets and the banking system in Cyprus constitute a matter of overriding public interest and public policy, justifying the imposition of temporary restrictions on capital movements.
A unilateral exit from the Eurozone (a breach of Treaty obligations) would inevitably add a further layer of complication to any assessment as to the legality of any controls imposed concurrently or sequentially with such an exit. This matter is too complex to be discussed in this article, and any detailed discussion will very much depend on the way in which any exit takes place.
Greece is under two programmes currently, a European programme and an IMF programme. The European programme expires at the end of June 2015 whereas the IMF programme expires on 15 March 2016.
The Greek Government has been in negotiations with the Brussels Group officials (formerly known as the Troika, comprising the European Commission, the ECB and the IMF) for the past few months with the aim of concluding the current programme review. This would set out all the conditions that need to be met before any further disbursements are made to Greece. The main areas of disagreement between the Greek Government and the Brussels Group officials appear to be the fiscal targets and budget gap for this year, privatisations, pension funds and collective wage bargaining.
Assuming an agreement is reached between these parties, this agreement would then need to pass through Greek Parliament to become law. This may prove to be challenging, given that the terms of such agreement would need to be approved by both SYRIZA's right-wing coalition partner, Independent Greeks, and the more radical elements of SYRIZA's own membership. It is possible that the Greek Government would see a number of MPs resign as a result of any such agreement and the law be passed only with the support of the opposition parties. Such a scenario may well lead to new elections, as the Greek Government would have lost its Parliamentary majority.
It may also be that the prospect of a loss of Parliamentary majority will force early elections in any event.
Alternatively, the Greek Government may opt to call a referendum raising the question of whether the Greek people want Greece to stay in the Eurozone and, if so, on what terms. Recent polls show that there is declining public support for the SYRIZA Government, which may tempt the Greek Government to call for a national referendum. The polls also indicate that there is an overwhelming public support for a European solution, though it is unclear on what terms the public would be prepared to accept to remain within the Eurozone.
Finally, an agreement reached between the parties may also need to be approved by each of the other Eurozone members. In some cases this approval may only be granted by the relevant Parliament. This may also prove challenging given domestic political considerations of Eurozone member States: for example the rise of Marine Le Pen's National Front in France, Spain's concerns about Podemos, as well as an apparent desire in Finland, Germany and Holland to be seen to get "tough" with Greece in order to appease their own electorates.
Even if the current review is successfully completed, it is expected that Greece will require further assistance in the form of a new European programme. It is likely that the Europeans will require the IMF to participate as well both by providing technical know-how and funds.
The next few weeks are critical. Greece is quickly running out of money and has several significant debt obligations to meet over the next few weeks as the calendar below illustrates.
While markets have been relatively sanguine about likely outcomes, it is impossible to predict with any precision how the moving parts in a monetary union and inter-connected global financial market will react and interact if a trigger event occurs.
Therefore, financial institutions, corporates and investors need to plan how to respond to any number of volatile market scenarios and be prepared to take and implement decisions on legal operational matters quickly. We have formed a pan-European team of multi-disciplinary experts to advise on the current and future legal implications of the situation in Greece and the Eurozone.
This core team has worked with clients responding to issues arising since the start of the financial crisis in 2008 and is actively tracking developments and keeping our core know-how updated on a range of key topics. If you are a client and have any queries concerning the crisis in Greece, please do not hesitate to contact the individuals below, or your usual A&O contact.