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The Novo Note Group

This ad-hoc bondholder group includes over 20 financial institutions, coordinated by Attestor Capital, BlackRock, CQS and PIMCO.

The institutions have in aggregate over $7 trillion in Assets under Management (AUM).

Many of the institutions' funds that have been impacted by this issue are mutual funds, whose units are owned by retail investors and by pension plans whose beneficiaries are individual savers.

Approximately €1.4bn. Banco de Portugal retransferred €2.2bn of bonds.

Actions taken by Banco de Portugal and Portuguese authorities in 2014 and 2015 regarding Banco Espírito Santo and Novo Banco had wide-ranging consequences for a large number of international and domestic investors, both institutional and retail. As a result, numerous different legal actions have been brought against Portuguese authorities in recent years by multiple parties. Much of this litigation is still ongoing.

The Novo Banco retransfer

Novo Banco was created as a "bridge bank" in August 2014 as part of the resolution of Portuguese bank Banco Espírito Santo (BES). BES's healthy operations and good assets were transferred to Novo Banco, while the [toxic assets] remained with BES. Novo Banco became the ‘good’ bank, and BES became the 'bad' bank.

On 29th December 2015, Banco de Portugal retransferred €2.2bn of bonds (across five different series of notes) from Novo Banco back to the ‘bad’ bank BES. For investors in those bonds, this imposed significant losses. These five series of bonds were governed by Portuguese Law.

Banco de Portugal’s decision to retransfer these bonds was not only unlawful, it also broke pari passu (by discriminating between equally-ranked creditors - and also discriminating between the holders of different series of notes issued under the same programme), and damaged Portugal’s credibility as an investment destination.

The Novo Note Group is pursuing legal action against Banco de Portugal and is attempting to reach a resolution that will allow the funds to continue their long history of investing in Portugal.

In total, five series of bonds were retransferred to BES out of a total of 52 series. It appears that this select series of notes were chosen for retransfer rather than others because they were the only notes subject to Portuguese law and jurisdiction (all others, bar one very small series, were governed by English law) – this allowed Banco de Portugal effective immunity from litigation outside of Portugal. Despite the challenges this presents, the Novo Note Group has filed an appeal in the Administrative Court in Lisbon to challenge Banco de Portugal’s actions.

The EU's Bank Recovery and Resolution Directive (BRRD) states that a resolution authority must set out in the instrument of resolution "the possibility that the specific shares or other instruments of ownership, assets, rights or liabilities might be transferred back" to the bank subject to resolution.  However, in the original instrument effecting the resolution of BES, creating Novo Banco and permitting the original transfer of assets from BES to Novo Banco, Banco de Portugal only included a general statement stating that it had the ability to re-transfer assets and liabilities back to BES, but did not set out the specific instruments that could have been made subject to that power.

As such, Banco de Portugal's decision to re-transfer the five series of notes was contrary to the provisions of the BRRD and other fundamental principles of Portuguese Law (namely the principle of legal certainty and protection of legitimate expectations)

Furthermore, Banco de Portugal’s use of the retransfer powers was unlawful because it failed to exercise those powers for the original purpose they were designed for. Rather than use the retransfer powers to correct the perimeter of the ‘good’ bank and the ‘bad’ bank, Banco de Portugal exercised the retransfer powers to fill the hole in Novo Banco’s balance sheet and fundamentally improve the bank’s financial condition. This is not what the retransfer powers were created for

The actions taken by Banco de Portugal have fundamentally damaged Portugal’s financial system, putting the country’s access to capital markets and wider economic recovery at risk. Portugal’s cost of borrowing has increased significantly as a result of the retransfer decision; sovereign spreads widened by 100 basis points in the week after the retransfer, which translates to €200m every year in additional interest expenses based on Portugal’s capital needs.

Without the support of international institutional investors, Portugal’s troubled banking system faces further risk of failure, as the burden of non-performing loans and provisioning requirements continues to weaken balance sheets and additional capital requirements fall due under EU regulations.

Ultimately, Banco de Portugal’s actions have hurt the country’s chances of mounting a full economic recovery. 

By retransferring €2.2bn of bonds (across five different series), Banco de Portugal's actions imposed significant losses on those bondholders, effectively nullifying the value of those notes.

Aside from significant material losses, the actions taken by Banco de Portugal have engendered a sense of distrust and disappointment amongst those noteholders affected. As long as Banco de Portugal continues to refuse to acknowledge and rectify its past mistakes, some of the world's largest investors have each come to the conclusion that they cannot safely invest in Portuguese public and private debt issuances.

The consequences of Banco de Portugal’s actions can still be observed today, both in Portugal and abroad. The issue is one of fairness - not even in the depths of its financial crisis did Greece ever break the key pillar of legal principles that is pari passu.

Portugal’s reputation as an investment destination will be permanently damaged until the central bank’s failings are acknowledged and addressed. Furthermore, the precedent set by a resolution authority acting contrary to its resolution powers and in breach of basic legal principles is a dangerous one, and is of fundamental importance for investors within the EU banking system given the universal application of the BRRD to the EU.

Novo Banco noteholders, including the Novo Note Group, continue to pursue ongoing legal action almost two years after the retransfer was made. Any investors that choose to ignore this situation as “old news” reinforce a dangerous precedent for allowing countries to unfairly discriminate against international investors.