The International Monetary Fund (IMF ) has joined a growing sovereign debt reform movement that aims to prevent repeats of the default drama engulfing Argentina, mostly by limiting the power of the holdout creditors that demand full repayments rather than accepting haircuts offered in debt restructurings.
But drastic limits on holdout power could in fact endanger the future of restructuring, if reform-minded agencies focus so sharply on Argentina they forsake bigger-picture concerns.
The proposed reforms center on two goals: first, to standardizecollective action clauses, which allow a majority of bondholders to approve restructurings applied to the entire creditor group; and second, to clarify common “pari passu,” or “equal footing,” clauses, whose vagueness doomed Argentina when one judge interpreted that country’s to mean its government couldn’t pay exchange creditors until it paid the holdouts.
Some oppose reform by arguing the changes could inflate nations’ borrowing costs as investors demand compensation for the loss of a future holdout option. That claim is flawed, though, because the high-risk funds that mine distressed debt for repayment opportunities mostly enter late in the game, since that’s when a country’s bonds are already so devalued that full repayment would mean astronomical returns.
Conversely, the audience for primary-market sovereign bonds is overwhelmingly dedicated, buy-and-hold investors. Since those funds are just as vulnerable as sovereigns to holdouts’ ability to derail restructurings, they have no reason to object to limits on minorities’ power.
The proof is in the prospectuses. Recent sovereign issuances show some countries already absorbing Argentina’s lesson and adjusting terms accordingly. Honduras issued $500 million in sovereign bonds in 2013, making sure to distinguish its pari passu clause from Argentina’s, as did Ecuador with its June $2 billion bond. Even with amended language, the bonds sold just fine: Honduras nabbed a 7.5-percent yield and attracted more than $1 billion in demand. Ecuador, only six years out from a default that should have crippled its market performance, saw $4 billion demand on the June deal, which yielded 7.95 percent.
Examples like these suggest pari passu reform is unnecessary. Collective action clauses, though, are another story. Groups like theInternational Capital Markets Association (ICMA) have suggested standardizing CAC thresholds at a two-thirds majority, instead of today’s 75 percent or 85 percent. But that change could spell disaster for smaller investors, who could be steamrolled by just a few major creditors teaming up to achieve the 67 percent majority and approve a biased restructuring proposal.
Sellside bondholders, with split revenue sources and conflicted interests to match, often have the incentive to do just that. In the 1980s, for example, large commercial banks propped up distressed Latin American sovereigns with revolving streams of cash, since allowing them to default would collapse the banks’ own overextended balance sheets. Smaller lenders’ opposition was silenced, since only the biggest banks had advisory committee seats. Only when the sovereigns fell back into default within a few years were the commercial banks’ motives appropriately critiqued.
Balance sheet concerns aside, the sellside also must contend with the reality their decisions could impact lucrative future underwriting or derivatives business with the sovereign.
As difficult as holdouts have made recent restructurings, their influence has also for years helped prevent sovereign issuers from exploiting smaller creditors with unjust exchanges. Reforms must not swing so far that restructurings become simply bilateral deals – with excessive collateral damage.
Eliza Ronalds-Hannon covers Latin American sovereign and corporate debt for Debtwire. She can be reached at Eliza.Ronalds-Hannon@debtwire.com