Greece on verge of debt forgiveness deal with creditors

The Greek government last night appeared to be on the verge of an agreement with some of its major creditors to restructure its bulging €355bn debt pile – although doubts remain about how many of the country's bondholders will sign up to the deal.

The strong possibility remains that a number of small hedge funds that have bought Greek bonds at distressed prices in recent months will refuse to give their assent, forcing the government of Prime Minister Lucas Papademos to retrospectively rewrite the terms of the debt contracts. It is feared that such a move could create a potentially dangerous new source of financial instability for the eurozone.

Talks in Athens between the Institute of International Finance (IIF), which represents the majority of Greece's bondholders, made progress yesterday, with reports suggesting that an agreement would be concluded to swap €200bn of existing Greek bonds for investments with a long term value of up to 70 per cent less.

Sources close to the discussions suggested that the new bonds would be repayable after 30 years and would pay out annual interest of 4 per cent. The last round of talks broke between the IIF and the Greek government about the size of the interest rate, technically known as the "coupon", on the new bonds. Greece is due to redeem €14.5bn in bonds that mature on 20 March. The country's official backers in the European Union and the International Monetary Fund have said they will not transfer the funds that Athens needs to meet that obligation unless the country and its creditors agree to restructuring deal.

Without those funds, Greece would be forced into a disorderly default, something that would create chaos throughout the European financial system. But even if a deal is done and those official bailout funds are delivered, hedge funds that are believed to be holding out for a large profit on the Greek bonds that they bought cheaply might refuse to sign up to the deal, forcing Athens to impose losses on them unilaterally.

Such a move would shatter any pretence that the restructuring deal is "voluntary" and would trigger Credit Default Swaps held by hedge funds and other investors in Greek debt. The financial firms that have written these financial insurance contracts would then register losses, creating another source of instability for the European banking system.

Two New York hedge funds – Och-Ziff and York Capital – confirmed this week that they have acquired Greek bonds, although they insisted that their holdings were small. They also confirmed that they have taken no part in the restructuring talks with the Greek government.