NEW YORK — Governments around the world have learned the lesson from Argentina’s conflict with bondholders who refuse to accept haircuts as part of debt restructurings and are now adapting their sovereign bond contracts to include so-called “anti-vulture” clauses.

Monday, March 23, 2015

Countries try to ward off ‘vultures’

NML Capital’s chief Paul Singer is seen in a file photo.

Governments are adopting new standards to prevent the purchase of distressed debt

NEW YORK — Governments around the world have learned the lesson from Argentina’s conflict with bondholders who refuse to accept haircuts as part of debt restructurings and are now adapting their sovereign bond contracts to include so-called “anti-vulture” clauses.

Countries are adopting new standards intended to thwart a strategy that has plagued Argentina for 13 years, in which buyers snap up distressed debt for pennies on the dollar and then hold out for full payment after other investors have agreed to restructure, using international courts as their payment enforcers.

Since August, as many as 12 of 22 recent emerging market issuers — including Ecuador and Mexico — have inserted language in their bond prospectuses that makes it prohibitively expensive for a single holdout to block a restructuring settlement that the majority of creditors may have accepted.

Ecuador, which also restructured its debt in 2009, issued new bonds this week that incorporate the language, developed by the International Capital Markets Association (ICMA).

Argentina’s situation — in which almost 93 percent of bondholders agreed to restructure defaulted debt, investors led by holdout funds Elliott Management and Aurelius Capital Management rejected the restructurings and blocked repayment to the majority of holders until they obtained full payment — is driving the move to change, lawyers and bankers said.

The new mechanism being adopted, known as the aggregated collective action clause (CAC), is aimed at preventing future implementation of the Elliott and Aurelius playbook.

“The new CACs crush the business model of the holdouts,” said Gregory Makoff, a senior fellow at Center for International Governance Innovation in Waterloo, Ontario.

“Holdouts thrive on buying small amounts of bonds that can’t be forced into a transaction,” said Makoff, who’s based in New York and formerly advised nations including Jamaica, South Africa and the Philippines on debt transactions during a career at Citigroup. “Now there is nowhere to hide since a supermajority can now sweep all bondholders into a transaction.”

To be sure, it may take decades for the holdout business model to completely wither away as old-style bonds mature, since the new language applies only to newly issued bonds. Trying to retrofit such language onto old bond covenants would be cumbersome and costly, lawyers said.

Both Elliott and Aurelius declined to comment on the new standards. Holdouts have argued that they play an important role in the credit markets by offering liquidity during distressed times. The new standards diminish their incentive to hold out on a deal.

In a nutshell, an aggregated CAC means all of a sovereign’s bondholders’ votes in a restructuring are counted in a single pool and if it passes the results are binding on all the bonds. That means if the supermajority of those votes agrees to a deal, then even those who don’t like the terms have no choice but to accept them.

The CACs aim to prevent a minority group of bondholders from holding up payments to others, as happened in Argentina’s case, spelling out that any restructuring can go ahead as long as there’s 75 pe approval from investors.

“Neither the sell-side, meaning the issuers, nor the hard money buy-side likes the result in Argentina,” said Antonia Stolper, a sovereign securities lawyer at Shearman & Sterling in New York. “For them it is a practical matter.”

Stolper said adoption of the new language by sovereign issuers for their international bonds, typically adapted to either English or New York courts, has been “spectacularly fast.”

Judge Griesa

The new covenants also include language written specifically to counteract the disputed opinion of US District Judge Thomas Griesa in Manhattan in Argentina’s case against its holdouts. Griesa’s view of the so-called pari passu clause, or equal treatment clause, is what the holdout hedge funds have used to win US$1.33 billion plus accrued interest.

“The modification to the pari passu clause diminishes investors’ ability to litigate,” said Moody’s Investors Service analyst Elena Duggar, who on March 13 published a study on the new language.

In October 2014 Kazakhstan adopted the new English law versions nearly verbatim, while Mexico led the way for bonds governed by New York law with an issue in November.

A simpler form of sovereign CACs were first used by Mexico in 2003, a milestone in the sovereign debt investment community. Those bonds matured earlier in this month.

In fact, it was the Mexican peso crisis in December 1994 and subsequent international bailout that launched an effort to design bond covenants that would lessen the burden on the official sector and shift it to private bondholders.

Belgian deputy central bank governor Jean-Jacques Rey headed a report issued to the G10 in 1996 that laid the groundwork for changes while the Argentine default in 2002 accelerated the effort to Mexico’s historic move in February 2003.

“It took about eight years for the initial CACs to go from the drawing board to the marketplace. The new CACs made the leap in less than two years — record speed in the arcane world of sovereign bond documentation,” said Makoff.

Market approval

Still, while the adoption of the new language has been fast, its effect on ratings, a key element on the pricing of deals, has been nil.

“From a credit point of view, we don’t think it will make a material impact on ratings. That decision is driven by the ability to pay,” said Moody’s Duggar.

There were some complaints, as the omission of the words “on the same terms” in the CACs seems to have been only belatedly noticed by some investors, causing some stir among them.

“The removal of that language is extremely concerning,” Aaron Kim, a senior vice-president at bond fund giant Pimco, told an industry conference last week.

But this hasn’t been so far reflected in market prices, where new bonds are being traded normally, backed by a host of international institutions.

The CACs themselves were not only designed by the ICMA, but given the stamp of approval by both the IMF and the G20.

Alejandro Díaz de Leon Carrillo, Mexico’s deputy undersecretary for public credit, did not explain why the words were left out — but shrugged off the importance of the omission.

“I don’t think those words are the silver bullet of this provision,” Díaz said. “This shouldn’t raise doubts about what the provision actually means.”

But the omission of the four words has since been copied in other bond issues by Colombia and the Dominican Republic — and included in the documentation of a pending deal from Panama.

Legal experts say the omission could give sovereigns more leeway in dictating the terms of any eventual restructuring.

“It is very interesting that those words are not in the terms of the bonds,” said Francis Fitzherbert-Brockholes of White & Case, which advised on a recent bond issue from Kazakhstan — the first to incorporate the recommended CAC language in full.

“Not having them allows the issuer much more flexibility in a restructuring,” he said.

When CACs were introduced by Mexico in 2003 the effect on market prices was negligible, say veteran bankers. That remains the case.

“Regarding CACs, I don’t think new issue bond pricing has been materially impacted by the inclusion of the new language to date,” Clayton Pope, head of emerging market bond syndicate at Crédit Suisse in New York.

Herald staff with Reuters