Italian and Spanish bonds rose today on speculation enough investors will sign up to the swap. Italy's 10-year yield declined 19 basis points to 4.75 percent, while Spain's 10-year borrowing cost dropped 7 basis points to 5.02 percent. Italy's yield premium to German bunds narrowed to the least since Sept. 1.

Greece needs to complete the swap to qualify for a 130 billion-euro bailout by helping drive its debt closer toward a target of 120.5 percent of gross domestic product by 2020, from 160 percent last year. Greece needs the cash to meet a March 20 bond redemption of 14.5 billion euros and dodge a default that would jeopardize the euro's existence.

The debt swap is "just another milestone on the long road to stabilize the euro," said Thomas Mayer, chief economist at Deutsche Bank in London. "What we're doing here is root canal work on the architecture of European Monetary Union."

The goal of the exchange is to reduce the 206 billion euros of privately held Greek debt by 53.5 percent. Investors with about 60 percent of the Greek securities eligible for the program had indicated participation by 11:20 a.m. in Berlin.

Greece's largest banks, most of the country's pension funds, and more than 30 European banks and insurers including BNP Paribas SA, Commerzbank AG and Assicurazioni Generali SpA have pledged to accept the offer. That brings the total so far to at least 120 billion euros, based on data compiled by Bloomberg from company reports and government statements.

Participation Goal

The government has set a 75 percent participation rate as the threshold for proceeding with the transaction, in which bondholders will receive new Greek government bonds and notes from the European Financial Stability Facility. Goldman Sachs Group Inc. analysts wrote on Feb. 28 that a voluntary participation rate meeting that target might allow Greece to proceed without making losses involuntary by enforcing so-called collective action clauses.

Default swaps on Greece, insurance contracts against non-payment, now cover about $3.2 billion of debt, down from about $6 billion last year, according to the Depository Trust & Clearing Corp. That compares with a swaps settlement of $5.2 billion on Lehman Brothers Holdings Inc. in 2008.

Compelling holdouts to take part will likely trigger payouts on those contracts, analysts said. A final decision would be up to the determination committee of the International Swaps and Derivatives Association, a panel of traders and investors who rule on whether swap holders can collect by handing over the defaulted debt in return for payment.

"I do fully expect to be part of the collective action clause," Patrick Armstrong, managing partner at Armstrong Investment Managers in London, said yesterday in a Bloomberg Television interview.

"There's a potential risk for the banking sector writ large across Europe and further abroad" from the clauses, as underwriters of the insurance have to pay out and seek funds to do so, said Erik Britton, a director of London-based Fathom Financial Consulting.

Activating the clauses also sets precedent, allowing countries such as Portugal to mimic the initiative and providing another reason to steer clear of European debt, said David Kotok, who helps manage about $2 billion as chairman and chief investment officer of Cumberland Advisers Inc. in Sarasota, Florida.

'Game Changer'

"The actual use of a CAC would be a game changer beyond Greece's borders," he said. "It says 'we can retroactively rewrite a contractual agreement.' It's one thing to threaten or cajole, but it's another thing to do it," Kotok said.

European finance ministers will hold a conference call at about 2 p.m. Brussels time tomorrow to discuss the swap result. German Finance Minister Wolfgang Schaeuble, speaking outside Florence, Italy, late yesterday, said that he's "quite optimistic" the debt exchange will succeed.

Given that Greece's debt load will remain at "very high levels" after the writedown, policy makers will have to rethink their strategy and consider further debt relief in the next "half a year," said Peter Bofinger, an economic adviser to the German government.

"What will have to be achieved is a real debt relief for Greece — and it will have to come in the next 12 months," Bofinger said in an interview today with Bloomberg Television.

Failure to seal a deal could imperil the pact Europe's policy makers wrapped up just days ago to provide a second bailout of Greece, said Jim O'Neill, chairman of Goldman Sachs Asset Management. Investor resistance would throw "a short-term spanner in the works" of the crisis-fighting effort, said O'Neill. "If it doesn't go through, European policy makers have to yet again do some nifty footwork," he said.

Even a Greek success in persuading lenders to forego what they are owed leaves challenges for the euro area. Joachim Fels, chief economist at Morgan Stanley in London, said he worries about complacency among governments which may tempt them to relax on economic reforms and fail to increase Europe's defenses against contagion.

"Europe's southern countries are still in a deep recession and struggling to meet their fiscal targets," Fels said in a March 4 note to clients. "If something goes wrong in the next several months, I think that banks will be more vulnerable due to their larger sovereign bond positions," and "the firewall will still not be big enough."

At Citigroup Inc., chief euro-area economist Juergen Michels warns Greece will struggle to reduce its debt enough to meet its bailout terms and still faces a 50 percent chance of leaving the euro. Spain's decision to revise its budget deficit target higher is another sign the crisis isn't over, he said.

"There is more disappointment out there," said Michels. "At the moment it looks relatively calm, but we doubt that we have seen that all the problems have gone away."

Bloomberg News

Copyright 2018 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.