Hedge funds are taking on the powerful International Monetary Fund over its plan to slash Greece's towering debt burden as time runs out on the talks that could sway the future of Europe's single currency.
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The funds have built up such a powerful positions in Greek bonds that they could derail Europe's tactic of getting banks and other bondholders to share the burden of reducing the country's debt on a voluntary basis.
Bondholders need to give up some 100 billion euros ($130 billion) of their investment in the planned bond swap, drawn up in October, but many hedge funds plan to stay out of it.
They either prefer letting the country go under, which would trigger the credit insurance they have bought, or hope to get paid out in full if enough others sign up. That puts them in direct conflict with the IMF, which wants to force Greece's cost of financing down to an affordable level.
"The play is purely 'they'll be forced to pay me'. Greece will want to avoid a wider default so if it managed to restructure 80 percent of the deal and pay the rest that's still better," said Gabriel Sterne at securities firm Exotix.
EU Economic and Monetary Affairs Commissioner Olli Rehn said on Tuesday that negotiators were "about to finalise shortly" . But time is running out.
Without the money, the country is likely to default around March 20, when a 14.5 billion euro bond falls due. A deal needs to come well before that, because the paperwork alone takes at least six weeks.
But the hedge funds are resisting, unlike European banks holding Greek bonds, who have been pressured to agree by politicians.
There are other barriers too.
Banks represented by the Institute of International Finance (IIF) agreed last year to write off the notional value of their Greek bondholdings by 50 percent, a deal designed to reduce Greece's debt ratio to 120 percent of its Gross Domestic Product by 2020.
But they have been unable to agree on the fine print of the refinancing - the coupon, maturity and the credit guarantees. These will determine the bonds' Net Present Value (NPV), and thereby the actual hit the banks need to take.
There are 206 billion euros of Greek government bonds in private sector hands -- banks, institutional investors, and hedge funds -- and it is likely that hedge funds have been building up their positions in the past months.
They have been snapping up chunks of Greece's next big maturing bond, the March 20, for around 40 cents on the euro. Yields on the bond began to rise sharply in September and it was priced at 41-45.5 cents in the euro on Tuesday.
The bet is that other creditors will sign up to a voluntary deal, and that Greece will pay out in full the hedge funds who do not to avoid a default and trigger pay-out of Credit Default Swaps, a form of credit protection.
"Time is on your side, since investors, until now, have received full repayment on Greek debt obligations," said Kristian Flyvholm at asset manager Jyske Invest.
Sterne, whose firm Exotix specialises in illiquid bond investing and counts hedge funds among its clients, said the bet had already worked for some funds. Greece paid out smaller issues maturing in December and January.
But it is a dangerous strategy.
Europe is increasingly likely to force investors to take a cut on their Greek bondholdings if they do not voluntarily sign up to the deal, Reuters reported in November.
Also, Greece could change its laws, which for the largest part do not contain the so-called Collective Action Clauses (CAC) that force dissenting minorities into line when new conditions are imposed on outstanding bonds.
It is unclear how large hedge fund holdings of Greek debt are. About 20 to 25 percent of Greece's creditors were unidentified, and half of these could be hedge funds, one source close to the creditors told Reuters.
Whatever the scale of the hedge fund threat, the proportion of creditors seen likely to sign up for their haircut has slipped. The hopes are now 60 percent can be convinced by the end of the month, the same source said, far less than the 90 percent take-up the IIF was targeting in June.
At that low a level, it is unclear whether the troika of international lenders will consider the uptake big enough to warrant a pay-out of the second bail-out package.
IIF Managing Director Charles Dallara is due in Athens later this week for troika negotiations, and technical staff from the IMF are expected in the Greek capital from Jan. 16.
The IMF itself seemed to throw doubt on the debt swap in an internal memo cited by German magazine Der Spiegel on Saturday.
According to the report, the IMF believes Greece will still be sinking under the burden of its debts even after a deal is struck, and that further measures may need to be taken if the country is to avoid default. Markets fear this could lead to reopening the October agreement.
In a leaked paper in October, the IMF already acknowledged that its the assumptions may need to be reassessed. That would mean lower interest rate payments by Greece, and an even more bitter hit for the banks.
The NPV loss for creditors could be near 65-70 percent and the coupon around 4.5 percent, bankers have indicated. Reuters reported in November Greece wanted a 75 percent NPV cut, a far higher number than the low 60s the banks had in mind.