The Design and Effectiveness of Collective Action Clauses (SM/02/173, 6/7/02) and Collective Actions Clauses in Sovereign Bond Contracts—Encouraging Greater Use (SM/02/175, 6/7/02).
In this paper, as in SM/02/173 and SM/02/175, the term collective action clauses (CACs) is used to refer to clauses that include both majority restructuring and majority enforcement provisions. The term “international sovereign bond” means a bond that is governed by a foreign law or subject to the jurisdiction of a foreign court.
A Fund staff member participated as an observer.
The G-10 Working Group has focused on documentation for sovereign bonds with the expectation that practices developed with respect to sovereign bonds could be implemented with appropriate modifications in other types of debt over time.
Can be found at: http://www.bis.org/publ/gten08.htm#pgtop.
These provisions are referred to in the G-10 Working Group Report as “majority amendment provisions”.
Modification of key terms could be achieved at an adjourned meeting with the support of bondholders holding 19 percent of the outstanding principal, i.e., 75 percent of the value of the bond issue represented at the meeting.
Although, to the extent that U.S. institutional investors use the EMBI Global as a benchmark, they would likely be holding bonds issued by Pakistan, Russia, and Ukraine, all of which are governed by English law, which includes majority restructuring provisions using the quorum approach.
As an alternative to an amendment of existing bond provisions, the G-10 recommendations also include a new feature allowing the bondholders of 75 percent of outstanding principal to accept an exchange of bonds for new instruments, the most common method of completing sovereign bond restructurings.
The six financial industry associations are the Emerging Market Traders Association (EMTA), the International Primary Market Association (IPMA), the Bond Market Association (BMA), the Securities Industry Association (SIA), the International Securities Market Association (ISMA), and the Emerging Markets Creditors Association (EMCA).
This high proposed threshold may be influenced by the private sector’s concern over a sovereign debtor’s control of a significant stock of outstanding principal in a particular issue, as may be the current case in Argentina. This issue is more directly dealt by the disenfranchisement provision.
Such a qualification does not apply to the Industry Associations Draft’s proposal for bonds governed by New York law, presumably because retail placements are more familiar in the London market.
For a detailed discussion of exit consents, see The Design and Effectiveness of Collective Action Clauses, SM/02/173 (6/7/02).
Under existing international bonds, a breach of a covenant would normally give rise to an event of default. Informal consultation with the preparers of the Industry Associations Draft suggest that such consequences may not be intended.
Since there is a strong correlation between governing law and the use of majority restructuring provisions in international sovereign bonds, data on governing laws can be used as a proxy for the use of CACs in bonds (see SM/02/175, 6/7/02 for an elaboration).
Bonds issued under New York law typically include majority enforcement provisions.
17 Non-U.S. dollar denominated bonds were converted into U.S. dollars at the current exchange rate. Brady bonds were not included.
18 See Petas and Rahman, “Sovereign Bonds—Legal Aspects that Affect Default and Recovery”, Global Emerging Markets—Debt Strategy, Deutsche Bank (May 1999); Tsatsanoris K., “The Effect of Collective Action Clauses on Sovereign Bond Yields”, in Bank for International Settlements, International Banking and Financial Market Developments, Third Quarter, pp. 22-23 (1999); Dixon and Wall, “Collective Action Problems and Collective Action Clauses, Bank of England Financial Stability Review (June 2000); Becker, Richards, and Thaicharoen, “Bond Restructuring and Moral Hazard: Are Collective Action Clauses Costly?”, IMF Working Paper WP/01/92 (July 2001); Gugiatti and Richards, “Do Collective Action Clauses Influence Bond Yields? New Evidence from Emerging Markets”, Research Discussion Paper, Reserve Bank of Australia (March 2003); and SM/02/175, 6/7/02.
Eichengreen and Mody, “Bail-ins and Borrowing Costs,” IMF Staff Papers, Volume 47, pp. 155-188 (2201). See also Eichengreen and Mody, “Would Collective Action Clauses Raise Borrowing Costs: An Update and Additional Results,” Policy Research Working Paper No. 2363, World Bank, May 2000.
Overall issuance by EU countries of international sovereign bonds is estimated to amount to roughly 3% percent of the outstanding stock of bonds (this includes issuance by an EU country in another EU country). However, while the share of international bonds issued by EU members is relatively small, the EU represents a sizeable portion of the global market. It is estimated that, since 1996, over € 37 billion in bonds was issued by EU countries through New York, and roughly € 6 billion through the German market - a possible indication of the impact future use of CACs could have on changing market practice in these jurisdictions.
Rule 144A provides a “safe harbor” from the registration statements of the U.S. Securities Act of 1933 and is often used for the secondary sales of unregistered securities to “qualified institutional buyers.”
Although the majority enforcement provisions contained in the Egypt and Qatar bonds would require the support of at least 25 percent of outstanding principal to accelerate the entire issue, individual bondholders would still have the right to accelerate their own claims.
In recent months there was a rally in the price of Egyptian bonds that was independent of the inclusion of CACs and was likely associated with the floating of the Egyptian pound, which was interpreted by the market as a positive credit event.
Among the terms subject to the 75 percent threshold are the provision on governing law and the submission to foreign jurisdiction.
Calculations on Mexico’s issue have varied depending on the methodology used, in particular in light of the complex nature of the Mexican sovereign yield curve. Some calculations showed a small yield premium of up to 10 basis points.
At the subnational level, the City of Buenos Aires recently completed a restructuring of its external debt, using the CACs incorporated in all of the City’s external debt instruments governed by English law.
Moreover, while it accepts their use in bonds governed by English law, it does not take a position as to whether they are preferable to fiscal agency agreements.
The 2002 Board paper also examined a range of other options for the Fund to promote the use of CACs, but most options were rejected as impractical or disproportionate. In particular, most Directors were opposed to the idea of conditioning access to Fund resources, in part because it was deemed unlikely that the Fund would consider withholding resources from a member that was otherwise willing to implement a strong adjustment program, in part because the link between the use of clauses and the macroeconomic objectives was weak, and in part because countries seeking access to Fund resources would often be ill-placed to change market practice, possibly stigmatizing the use of clauses (BUFF/02/99).