Europe seems to want to change the culture of their banks and bondholders from one of “gentlemen’s understandings” that governments and equity holders will suffer all the pain in the case of bank failure to one where legal and covenant obligations will be enforced–meaning bondholders, too, will participate financially in bank restructuring.

One vehicle being pushed in the contingent convertible, an instrument that I’ve regarded as a top-of-the-market gimmick that looks good on paper but has the potential to end in tragedy.  European governments appear to be pushing it as a concept, however, because COCOs spell out explicitly what the bondholders’ obligations are in case the issuer has difficulties.  There’s no room for negotiation, no ability for a politically connected holder to put pressure on the bank regulator to take a soft stance on a certain tranche of bonds.

Europe appears to me to be taking this new attitude a giant step farther in the case of debentures of the failed Anglo Irish Bank, a property-oriented institution that proved to be a monument to opacity in lending.

The Irish government is offering to issue new, Dublin-guaranteed, bonds to holders of about €3 billion of various tranches of AIB debentures.  The rate of exchange would be: 1€ of the new issue for every 5€ of the old debt.  Holders of the affected AIB bonds, many of whom will, I think, prove to be hedge funds that bought in the secondary market after AIB failed, have squawked.  Their expectation apparently was to receive new bonds at something more favorable than a 4/1 rate.

Voting on the Dublin/AIB proposal will take place in December.

None of this is too surprising.  The rest of the government’s plan is, however.

According to the Financial Times, Dublin also wants accepting bondholders to agree to change the bonds’ covenants to provide that any holders who do not accept the offer will be forcibly redeemed at .001% of par–basically nothing.

Again, according to the FT, a result in favor of the exchange at the initial meeting requires that holders of two-thirds of the bonds vote and the 75% or more of the votes say yes.  If less than the required two-thirds attend the initial meeting, a second can be called at a lower quorum level.

Bloomberg says that investment bank Houlihan Lokey, representing a large enough proportion of the affected bondholders to defeat the proposal, intends to vote no.  The Irish legislature has also chimed in, suggesting it will pass a law allowing the exchange to occur without regard to the vote results, should bondholders reject the offer.  Houlihan Lokey apparently wants to negotiate with AIB, but the bank has refused.

This should be interesting.  Stay tuned.