It’s 1am on Thursday, October 27 2011. In the offices of Herman Van Rompuy, the president of the European Council, the then French president, Nicolas Sarkozy, and German chancellor Angela Merkel continue to strong-arm Charles Dallara, the lead negotiator for private creditors, in a make-or-break deal for the eurozone. The aim: compelling banks to swallow further losses on Greek sovereign debt holdings.
Global markets are poised on a knife-edge. A game of bluff – over what would be the largest sovereign debt restructuring in history – drags on. Merkel is civil. But in public comments in previous weeks, the chancellor had played hardball, suggesting Germany could stomach a Greek credit event amid bailout fatigue.
Meanwhile, Dallara, who is in charge of co-ordinating private-sector creditors in his capacity as head of the Institute of International Finance, touts the risk of a Lehman-like collapse in global markets if investors are forced to swallow an involuntary restructuring.
At the negotiating table, Sarkozy, as befits his bellicose demeanour, plays bad cop. He attempts to hector Dallara into offering deeper haircuts, citing how an unpopular deal would further bloody the reputation of the banking industry. Merkel, Sarkozy and Christine Lagarde, IMF managing director, are united as they draw a line in the sand: private-sector losses should help to stabilize Greece’s debt burden to 120% of GDP.
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In the negotiations, Dallara, flanked by Jean Lemierre, co-chair of the private-creditor committee for Greece and former European Bank for Reconstruction and Development president, moots the prospect of deeper notional discounts than the 21% haircut offered earlier in the year. Dallara’s argument is seemingly gaining traction: the elusive 120% debt-to-GDP target shouldn’t serve as a dogmatic benchmark to calculate the necessary private-sector held debt losses but, rather, should influence Greek reforms and a rescue package over a medium-term economic cycle.
What’s more, face-value discounts need to be softened by big sweeteners from eurozone members to boost the value of remaining bonds, Dallara argues. After lambasting Dallara hours previously – with the double-edged taunt that his historically low poll numbers still make the French president eminently more popular than the bankers – Sarkozy relents: "You make your point well," he says in French.
With a deal of sorts taking shape, Dallara phones Josef Ackermann, the then chief executive of Deutsche Bank and chairman of the IIF board; and Douglas Flint, HSBC chairman; among others. He duly receives the green light from these crucial, battle-weary creditors and IIF confidants. Dallara is subsequently handed over a copy of the draft eurogroup communiqué by Merkel and entrusted to amend the language as he deems fit.
By around 5am, both parties, Dallara and Europe’s leaders, claim victory: a formal credit event is averted. Banks swallow a 50% haircut (later amended to a 53.5% face-value loss), with a low coupon. The taboo of the IMF and European Central Bank taking write-downs on their debt is avoided. A €100 billion debt reduction for Greece is facilitated. And global markets rally in tandem with a eurozone crisis package.
In the subsequent months, the IIF chief visits Athens multiple times – flanked by security whenever he ventures outside his hotel and government offices – to flesh out the terms of the historic voluntary private sector involvement (PSI) agreement. The deal is under siege amid the Greek referendum and objections from Luxembourg, among other factors. In one difficult meeting with the then Greek prime minister, Lucas Papademos, to discuss the coupon and maturity in the debt swap that would determine the losses for investors, Dallara takes Papademos out of the room, asking for the unwieldy circus of special advisers, junior ministers and aides along with high-ranking officials, to be downsized. An hour later, Papademos obliges and returns with half of his entourage.
These episodes highlight the IIF’s often-misunderstood role in international financial diplomacy and Dallara’s intimate involvement in the torturous Greek debt restructuring – the climax to a near two-decade career as head of the Washington-based institute.
Dallara, 63, the outgoing IIF managing director, has overseen the growth of the institute from its roots as an informal group of predominantly US and Japanese commercial banks that negotiated Latin American debt restructurings. Its expansion – and now direct involvement in sovereign debt restructuring in western Europe – is a microcosm for the shift in global financial power and the structural shifts in the financial industry. It operates today as a trade association for financial institutions with cross-border exposures of all stripes, including investment banks, asset managers and insurance companies. It now boasts a membership of 461 financial firms, around half headquartered in emerging markets, and last year picked up insurance companies with exposure to Greece. In short, the institute’s modest workforce, over 90 full-time employees, belies its strategic importance in bank lobbying on regulatory and sovereign debt affairs, research and industry coordination.
At first blush, Dallara is well positioned to navigate the Greek debt restructuring – a deal that, as Euromoney was going to press, might yet come unstuck as eurozone lenders continue to play hardball. His extensive experience, knowledge and contacts garnered from a stint at the US Treasury in the first Bush and Reagan administrations in the 1980s and early 1990s during successive developing-country debt crises, particularly in Latin America, complements his private-sector experience as an emerging market executive at JPMorgan. Nevertheless, the Greek deal is no Brady-era plan. It’s a historically unique case of sovereign debt restructuring by virtue of its magnitude, the disunity of the official sector creditors (ECB and eurozone governments), breadth of private-sector claims and the IIF’s mandate to lead the international creditor consortium.
The Greek saga is a much-coveted opportunity for Dallara to portray himself on the global stage – amid the scrutiny of the international media – as that rare beast: a humble, articulate and sensible apostle for bankers, striking a judicious balance between debt sustainability and voluntary private-sector participation.
But his legacy rests on thin ice. The twin principles of sovereign debt restructuring – as preached by his former mentor, Citi’s Bill Rhodes, for example – aim at crafting a sustainable debt profile for the government in question, which should also claim authorship of any deal to tout its virtues to a reluctant populace.
The Greek package fails on both counts. All private-sector economists and market players reckon the slew of recent bailouts, write-downs and austerity measures will fail to cap Greece’s debt-to-GDP ratio to 120% by 2020 and think the troika has factored in delusional growth assumptions. As Euromoney was going to press, the risk of the collapse of the rescue package loomed large, and with it the threat of further principal write-downs, not to mention a Greek eurozone exit, amid a row in northern Europe over whether or not Greece should remain in the single-currency bloc.
Speaking to Euromoney in his IIF office in Washington, Dallara, who spent two years in Greece as a young US naval officer, lays the blame squarely with the official sector, arguing that private creditors have already suffered disproportionately large losses.
"I am not in favour of trying to force the creditor that is providing new money to also restructure in a fundamental way the net-present-value terms of their claims," he says. "There is an inherent difficulty of convincing someone to write down their old cheque while writing a new cheque. However, the public sector has failed more generally to demonstrate sufficient flexibility over their claims in Greece and other eurozone countries."
In addition to relaxing austerity targets in Greece, Dallara says bailout loans via national governments or pan-eurozone fiscal authorities, such as the European Financial Stability Facility, should be reduced to core-cost level. He criticizes the opaque manner of the ECB’s €50 billion Greek sovereign debt swap for new Greek bonds of equivalent value in late February, which are not subject to collective action clauses and thus future involuntary write-downs.
He argues that the ECB could have "written down the value of Greek debt to the haircut level, which would have given Greece some breathing room while the ECB had some embedded cushion." Although the ECB’s profits from its Greek debt holdings were said to have been redistributed to national authorities to help finance the rescue package, this "torturous and circuitous route" undermined market confidence.
Dallara has a point. The ECB, since the July meeting, accepts the market-distorting impact of official-sector debt purchases that gain seniority over private holders. Dallara’s message is clear: fears that private eurozone sovereign bond holdings are subordinate to the official sector will continue to cause market distress, especially given the perception in the market that public officials will change the rules of the game to ensure their holdings are insulated from write-downs, come what may. "When the ECB and others in the official sector say they are holding the sovereign claims to stabilize the market – they need to remember that many banks are doing the same," he says.
The logical conclusion of Dallara’s argument about the ECB’s involvement in Greece is that – in addition to dealing with the seniority question – the official sector could consider taking self-imposed haircuts on sovereign debt and transferring the benefits to private creditors or distressed sovereign borrowers, directly or indirectly, to ensure the potency of future bond-purchasing programmes.
Perhaps surprisingly, Dallara reserves much of his fire for the IMF. Although not disputing the principle of the IMF’s preferred creditor status, he said the fund had failed to act in good faith in Greece, prioritizing repayment over its role as economic stabilizer, setting a negative precedent for further bailouts. "They would overly emphasize the 120% debt-to-GDP ratio – this ratio is no golden nirvana – as a means to squeeze the private sector to accept a lower interest rate on their future claims," he says. "They also kept hidden throughout the negotiations the amount of money they were going to put in the Greek rescue package."
It’s not clear what role the IIF might take in any future sovereign debt restructuring in peripheral Europe or elsewhere. Dallara says the institute would be prepared to act if requested on a case-by-case basis, but that there should be no ex-ante assumption. It has established a new joint committee of bankers, senior fiscal and monetary officials as well as multilaterals, to explore new approaches to the prevention and resolution of sovereign debt crises.
But the more things change, the more they stay the same. The same mission – to flesh out a set of procedures for sovereign bailouts amid a disconcerting lack of harmonized principles – took root in 2004 after the Argentine debt fiasco. The result was a lowest-common-denominator approach, which emphasized a set of guidelines and was bedevilled by concerns over the breadth and quality of the collaboration in the process.
The Greek saga throws into sharp relief two key lessons. The first is that sovereigns and official-sector creditors have substantial freedom and, thus, a self-interest in determining the priority structure for repayment that suits them. Although the eurozone crisis underscores the need for a framework to make the relative priority of sovereign claims more transparent, it’s unclear if it’s possible to develop a system that can be agreed and enforced.
When he was at the US Treasury, Dallara worked on the other side of the negotiating table. A fascinating footnote in World Bank: History, citing a 1990 National Review article, notes: "William Dale, former deputy manager of the IMF, was quoted as saying David Mulford and Charles Dallara, the purported designers of the Brady plan in the US Treasury, ‘must have had holes in their heads’ since banks do not offer fresh money to the same clients for which loans are being marked down."
The conclusions from the Brady era are still relevant now: the official-sector community is divided; and convincing creditors, private or public, to boost their positions while incurring face-value losses is a tall order – factors that complicate current efforts to flesh out sovereign debt restructuring principles before they are needed.
The second lesson from Greece is that the ambiguity and volatility of the sovereign debt market buttresses the IIF’s core mission as an intermediary between the official community and private financiers. Dallara’s public-policy experience, serving as assistant Treasury secretary for international affairs for two years to June 1991 – aside from helping the IIF to win the Greek mandate – pervades the institute’s culture. IIF insiders consider themselves as a bridge between the public and private sector, says Greg Frager, an IIF veteran since 1984 and now Asia-Pacific research chief. The merry-go-round between politicians and financiers serving on IIF-backed working groups and special committees buttresses this claim.
Much of the IIF’s lobbying takes place behind closed doors, rather than in the full glare of the press. Common to many pitches is the virtue of marrying voluntary industry self-regulation and self-assessment (such as annual IIF surveys on risk-governance frameworks) with government supervision to address cross-border systemic risk.
Dallara – who before meeting Euromoney held a routine call with Mark Carney, Canadian central bank governor and chairman of the Financial Stability Board – rarely shoots first and asks questions later. Instead, three layers of consensus-building typically kick in, Dallara says, at the CFO level, then CEO and then at the IIF board level.
This degree of consensus is usually backed up by research and a working group to discuss the formation and implementation of voluntary industry principles. The institute considers itself effective when it seemingly pre-empts or crafts official-sector policies, such as the IIF’s principles for industry compensation practices in mid-2008 that it reckons have been largely adopted by the Financial Stability Board. In short, the IIF rarely engages in advocacy on the fly. This process is designed to reduce the risk that it is publicly perceived as a well-oiled lobby group that cries foul in a knee-jerk fashion.
The IIF’s research franchise – established in the mid-1980s to give bankers a better view of sovereign risk, compared with verbose IMF Article IV agreements – strengthens the credibility of its outreach while its capital-flow projections to emerging markets serve as a benchmark for the industry.
But the IIF is only as powerful as the mandate its vast, diffuse and diverse membership entrusts it with, which means it is bedevilled by policy dilemmas, often adopts the lowest-common-denominator approach, picks its battles selectively, and might at times appear to be spread too thinly.
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| Charles Dallara criticizes the stance of the IMF in the Greek debt negotiations |
On divergent interests in the Greek sovereign debt restructuring, Dallara admits: "Sometimes it gets bloody, but when it gets bloody you ask people to cool off and you get back to the dialogue." He rebuffs pressure from some bankers for financial institutions to claim seniority over institutional investors – many of which are also IIF members – in the private-sector creditor hierarchy for sovereign debt.
Granted, in the Greek deal, the decision-making ultimately rests with the IIF membership, with Ackermann serving as the key behind-the-scenes architect, before he stepped down this spring. But Dallara has proved critics wrong: he has helped private creditors overcome the cat-herding challenge – including state-supported banks and hedge funds – in sharp contrast to the fragmentation in the eurozone polity.
Representing an array of diverse private-sector creditors can involve daily, confidential discussions with at least a dozen CEOs. Dallara frequently fires off text messages to the key creditors; before eurogroup summits they contained the instruction: "This is the night you keep your phone on".
One noteworthy policy battle in recent years is reflected in early, unreleased drafts of IIF statements when the institute was forced to roll back from promoting centralized financial institutions as more-efficient business models than the subsidiarity model, in response to regulatory pressure to reform global banks into holding companies for separately capitalized subsidiaries. The softening of the IIF position followed pressure from prominent members of the institute who take pride in the principle of subsidiarity – Santander and HSBC, whose chairman Flint has taken over from Ackermann as IIF chair.
In a sense, though, the IIF’s diversity is a strength. The institute’s global membership forces it to focus on cross-border issues, providing it with some moral authority to opine on grand issues such as financial globalization, leaving other lobbying groups to launch skirmishes with legislators and regulators on granular reforms, such as derivatives rules.
As Wayne Abernathy, executive vice-president for financial institutions policy and regulatory affairs at the American Bankers Association, says: "I am constantly impressed by the IIF’s ability to get invited to international meetings. Dallara has certainly raised the credibility of the institute, among international standard setters. And it helps that the IIF is not seen as just representing US banks but banks internationally."
In truth, the IIF’s lobbying effort is probably a drop in the ocean, given the penchant of global banks for spending millions of dollars on political influence.
The IIF is also much more likely to operate in an outreach and advisory capacity for bankers, rather than in an operational capacity, given the range of opinions of its membership and the operational mandates of rival lobbying organizations, such as the American Bankers Association. The Greek case was an exception. The IIF’s mandate was forged by the sheer diversity of private-sector creditors, the high stakes involved, the faith invested in Dallara and the unity of private creditors against institutional and political failure in the eurozone.
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| William Rhodes, veteran Citi banker, tells Euromoney. Rhodes, an IIF board member for over two decades until 2010 and author of Banker to the World: Leadership Lessons From The Front Lines of Global Finance |
Rather than firefighting eurozone sovereign debt crises, the IIF’s core mandate is to promote financial globalization, as William Rhodes, veteran Citi banker, tells Euromoney. Rhodes, an IIF board member for over two decades until 2010 and author of Banker to the World: Leadership Lessons From The Front Lines of Global Finance, who recommended Dallara to the IIF board in 1993, says: "A growing role for the IIF should be to point out to financial institutions how they can better themselves on the risk and regulatory side, while providing up-to-date economic research." It’s an issue dear to Dallara’s heart. By seeking to craft a smaller global banking system with silos, such as the ring-fencing of liquidity and capital buffers, financial regulators are slamming the brakes on globalization and its attendant economic benefits, he says. "The central banking and regulatory community in general have done a mediocre job in owning up to their mistakes in contributing to the crisis and the troubles post-crisis. They owe it to their constituents to articulate a view that prosperity and stability won’t arise if we take a nationalistic, fragmented and beggar-thy-neighbour view of financial regulation."
While the IIF rages against the regulatory machine, its detractors say the institute makes manipulative claims, in its capacity as defender of the pre-Lehman global banking model, which failed to detect the rampant risk-governance failings and leverage of its members and that profited handsomely from the era of financial deregulation.
The role of Peter Wallison – an aggressive proponent of financial deregulation and a former Treasury official in the Reagan administration – as secretary to the IIF board does little to soften this critique. More fundamentally, the IIF serves as a conduit for "regulatory capture" – where supervisors sacrifice their perceived public interest in favour of vested banking interests, aided by financial and personal ties between elites in Wall Street and Washington, Simon Johnson, former IMF economist and outspoken banking critic, has noted.
IIF studies on the negative-growth impact of financial regulation – that contrast with sanguine conclusions from Basle’s Bank for International Settlements – are lobbying efforts "masquerading" as empirical analysis, paid for by its sell-side membership, according to Johnson. What’s more, critics of the global banking model, even within the IMF research department, say the crisis demonstrates that a large financial sector relative to national GDP is often associated with a lower and more-volatile economic growth path.
But financial laissez-faire is dead. Conscious of swimming in vain against the regulatory tide, the IIF now aims to water down some of the Basle proposals, such as an overly prescriptive liquidity coverage ratio and the net stable funding ratio, as it reckons these will be the kiss of death for banks as maturity-transformers, as well as elements of the US Dodd-Frank rule.
The IIF broadly supports structural shifts in capital and risk-management regimes, but argues that market pressures to accelerate the adoption of Basle III capital rules, and a flurry of different banking reform timetables and capital definitions, have served to undermine credit transmission.
There is no intellectual dishonesty in these claims. IIF insiders are by no means genetically designed attack dogs for reckless financiers, as caricatured in the court of public opinion in the polarized and heavily politicized debate on global regulatory reform. And the jury is out on whether or not certain pillars of financial regulation, as currently proposed, are dangerously pro-cyclical, risk creating another bubble in the shadow banking system, and create extra incentives for banks to take on more risks.
What’s clear is that the IIF’s moral authority and leverage to tout the so-called virtues of free-market regulatory liberalism have been undermined by the marked indiscretions of its members this year, from HSBC’s money-laundering drama, Nomura’s insider-trading scandals, Barclays and Libor-gate, Standard Chartered’s Iran probe and the JPMorgan chief investment office saga.
The instinctive defence from some quarters of the banking industry – that these are, generally speaking, unrelated cases of risk-governance failings that market and current supervisory mechanisms will address – flies in the face of consensus among policymakers: ever-tighter financial regulation is needed to reduce risk-taking and that global universal banks are still too complex to manage. What is Dallara’s view? "It is important for our constituents to realize serious mistakes have been made and to make serious efforts to shareholders, clients and society at large to address this," he says. "If we could create a more inter-woven set of relationships between industry and supervisors, it would mitigate the need for overly onerous regulations." When pushed Dallara eventually loosens up: "Bankers have made serious mistakes and they deserve to be held accountable, but they are not the arch-enemy here. We have to be seen as partners with the official community, and that will not happen if they continue to vilify us."
Dallara, like HSBC’s Flint – the new IIF chairman and a smart but sedate former accountant – is well suited to this politicized climate. His successor, expected to be installed by the institute’s spring meeting next year, needs to be seen by the official sector as an effective coordinator of the private sector.
And above all, the new IIF chief should pounce on event-driven crises to ensure that the institute has an operational role on either sovereign debt restructuring or financial reform. Failure to do so will relegate the IIF to a talking-shop for financiers, preaching light-touch regulation to a vanishing group of sympathizers. And Dallara’s legacy will have come unstuck.