Tag Archives: Pari passu

“Sovereign Bond Prices, Haircuts, and Maturity,” NBER, 2017

NBER Working Paper 23864, September 2017, with Tamon Asonuma and Romain Ranciere. PDF. (Local copy.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” CEPR, 2017

CEPR Discussion Paper 12252, August 2017, with Tamon Asonuma and Romain Ranciere. PDF. (ungated IMF WP.)

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

“Sovereign Bond Prices, Haircuts, and Maturity,” IMF, 2017

IMF Working Paper 17/119, May 2017, with Tamon Asonuma and Romain Ranciere. PDF.

Rejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.

Argentina to Resolve Litigation and Return to International Capital Markets

In the FT, Daniel Politi and Pan Kwan Yuk report about an agreement between Argentina and four holdouts, yet to be implemented by Congress.

A few weeks ago, New York judge Griesa had indicated that he would lift the injunction preventing Argentina from servicing its restructured debt. This improved Argentina’s bargaining power. According to The Economist, Griesa had written: “President Macri’s election changed everything. … The Republic has shown a good-faith willingness to negotiate.”

Pari Passu and Collective Action Clauses: The New World

An IMF staff report published in September and entitled “Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring” discusses recent legal developments of relevance for sovereign debt markets and implications for the sovereign debt restructuring process.

The New York court decisions (NML Capital, Ltd v. Republic of Argentina) have rendered a holdout strategy more likely to succeed. This tends to exacerbate collective action problems and raises the risk of more protracted debt restructuring processes. Market participants, including the International Capital Markets Association (ICMA) are discussing contractual clarifications and modifications in response to this challenge. The IMF observes these discussions and supports the preliminary results.

The New York court decisions established a broader interpretation of the standard pari passu clause in sovereign debt contracts. Specifically, they extended the standard notion of “protection of a creditor from legal subordination of its claims in favor of another creditor” to the broader notion that a sovereign must pay creditors on a pro rata basis. The court decisions prohibited Argentina from making payments to holders of restructured bonds unless it paid holdout creditors on a pro rata basis, and it prevented banks from making payments on Argentina’s behalf. In this context, the decisions also interpret the U.S. Foreign Sovereign Immunities Act. The scope of the rulings is not clear, not least because the decisions also refer to Argentina’s “course of conduct.” If interpreted broadly, the court decisions change the legal framework and are likely to complicate the restructuring of New York law-governed debt contracts (while probably not affecting London law-governed contracts).

Box 1 of the report discusses in detail the history of the Argentine litigation in the U.S. The report also contains an annex on the history of pari passu clauses in New York law-governed sovereign debt contracts.

Sovereign issuers have already reacted to the court decisions, by modifying the pari passu clauses in debt contracts. Also, ICMA has proposed a new standard pari passu clause, emphasising equal ranking as opposed to pro rata payments.

Collective action clauses enable a qualified majority of bondholders (e.g., 75%) of a specific bond issuance to bind the minority to the terms of a restructuring agreement. If collective action clauses operate on a series-by-series basis rather than on the total stock of debt then a blocking minority can more easily be formed and a strategy of holding out is more likely to succeed, in particular in light of the recent New York court decisions. The possibility to aggregate claims across bond series for voting purposes works in the opposite direction. Some countries have included aggregation clauses in the debt contracts, and the ESM treaty requires standardised aggregation clauses (“Euro CACs”) in Euro area government bonds as well. These clauses feature a “two limb” voting structure, requiring a majority of bondholders in each series and across all series but a lower quorum (e.g., 66%). Currently, “single limb” procedures are being discussed. These would solely require a majority across all series. To prevent abuse, such single limb procedures would have to be accompanied by safeguards that ensure inter-creditor equity, in particular a restriction to offer all affected bondholders the same (menu of) instruments. (Offering the same (menu of) instruments would generally imply that some creditors suffer larger restructuring losses than others, depending on the type of instruments they held initially. But already today, this is common and generally accepted.)

Box 2 of the report discusses the history of collective action clauses. Box 3 of the report discusses disenfranchisement provisions. Their purpose is to limit the risk of a sovereign manipulating voting processes by influencing votes of entities under its control.

“Credibility For Sale,” CEPR, 2013

CEPR Discussion Paper 9562, July 2013, with Harris Dellas. PDF.

We develop a sovereign debt model with official and private creditors where default risk depends on both the level and the composition of liabilities. Higher exposure to official lenders improves incentives to repay but carries extra costs, such as reduced ex-post flexibility. The model implies that official lending to sovereigns takes place in times of debt distress; carries a favorable rate; and can displace private funding even under pari passu provisions. Moreover, in the presence of long-term debt overhang, the availability of official funds increases the probability of default on existing debt, although default does not trigger exclusion from private credit markets. These findings help shed light on joint default and debt composition choices of the type observed during the recent sovereign debt crisis in Europe.

Foreign-Law Sovereign Debt

The Economist discusses the consequences of issuing sovereign debt under foreign law. Investors in Greek government debt did better if they owned paper governed by English law—these series escaped the retroactive addition of collective-action clauses that Greece added to its domestic law bonds in 2012 before renegotiating with its creditors. For Argentine debt the situation may be reversed, due to the New York court decision in the case of Elliott Management against the Republic of Argentina. Indeed, default risk might be lower for Argentine domestic-law bonds.