BRAZIL'S $1 BILLION BOND issue at the end of
April took the markets by storm. The timing and the pricing
were nigh-on perfect: the most difficult part of the deal was
deciding how many bonds each of the 430 participants in the
over-$7 billion order book was going to get. So it was with
some surprise that Euromoney picked up the telephone the
following morning only to hear a string of fluent invective
aimed at Brazil and its advisers. "Testicular weakness" was
one of the more memorable phrases used.
The caller was from the official sector, but was not part of
some zealous minority at the IMF. In fact, many private-sector
observers took a similar view.
The problem was simple: why had Brazil issued bonds with 85%
collective action clauses, or CACs? Everybody had assumed, before
Brazil came to market, that not only were CACs here to stay but
that the market had standardized on a 75% threshold of bondholders
needed to change the payment terms on any bond. After all, that's
what Mexico, the trailblazer, had done; that's what Uruguay had put
into its own exchange offer; and that's what the G7 countries had
said they would do in their own issuance.
What's more, it was blindingly obvious from the success of the
deal that Brazil had no need whatsoever to increase the threshold
from 75% to 85%. The extra 10 percentage points in CAC threshold
made no difference at all to the level at which the bond priced
when it came to market: Brazil didn't save any money by making it
that much more difficult to renegotiate its new, CAC-laden
debt.
A number of theories started winging their way around the
market. The first had to do with the lead managers. UBS Warburg and
Merrill Lynch are fine at lead managing bond issues, but aren't
known to house experts on the finer points of CAC issuance. Shops
with in-house experts, such as JPMorgan and Citigroup, would
probably have had more confidence in telling Brazil that
bondholders' bark was worse than their bite. What's more, UBS
Warburg's chief Latin America economist, Michael Gavin, who does
know a lot about the subject, is - properly - very close to the buy
side and has hosted meetings of the Emerging Markets Creditors
Association.
EMCA reacted loudly and negatively to Mexico's 75% CACs, raising
the possibility that they would behave in a similar manner were
Brazil to follow suit. Mexico can afford largely to ignore EMCA's
wailings, because dedicated emerging-market investors make up a
very small part of Mexico's investor base. But Brazil needs as many
investors as possible on its side, since it is far from out of the
woods yet. If 85% CACs would make EMCA happier, Brazil probably saw
little harm in adopting them. It would certainly help on the
goodwill front, and while it wouldn't make any difference on this
particular bond issue, it might, at the margin, make a difference
in the future.
Marcelo Delmar, head of Latin debt capital markets at UBS
Warburg, says that "Brazil saw very clearly that 85% was what the
investment community wanted, and Brazil embraced the recommendation
that the investment community had put to them".
Conspiracy theorists, however, identified an individual whom
they blamed for the elevated level of Brazil's CACs: Eli Whitney
Debevoise II, the partner at law firm Arnold & Porter in
Washington DC who advised Brazil on the issue. Debevoise is a
veteran in the world of emerging-market debt, but as one friend
says of him: "Whitney is a pretty consensus-oriented guy: his
advice to Brazil has always been better safe than sorry." The thing
that excited some observers, however, was that as well as advising
Brazil, Debevoise was also advising both EMCA and EMTA, the
Emerging Market Traders Association.
EMTA's executive director, Michael Chamberlin, had been first
among equals in drafting what he calls the "marketable CACs": the
model clauses for would-be CAC issuers that were put out jointly by
half a dozen trade associations and then promptly ignored when
Mexico actually took the plunge. The marketable CACs had a
threshold of 85% with a 10% veto, making them much closer to
Brazil's bond than to Mexico's.
Indeed, immediately after the Brazil issue came out, a few EMTA
members found themselves in receipt of an "investor-oriented
scorecard," also drafted by Chamberlin, in which he graded the
three issuers of CACs on a scale of one to five. Uruguay got 3.57,
Mexico got 4.00, and Brazil, thanks to its 85% threshold, got an
impressive 4.33. (The marketable CACs got 4.82, since the threshold
was 85%, rather than 95%; EMCA's own covenants, which pre-date the
marketable CACs, got a full 5.00.)
The Chamberlin scorecard does look a little bit as if it has
been reverse-engineered from a pre-existing idea of where the
different countries should place. Mexico and Brazil, for instance,
score four out of five for subscribing to the IMF's Special Data
Dissemination Standard, even though they don't covenant that
subscription in their bond documentation as EMCA and EMTA would
like them to. Uruguay, on the other hand, which does have data
dissemination clauses in its new bonds, still manages to score
lower than Mexico and Brazil on "Reporting/Disclosure".
Meanwhile, Uruguay gets harshly penalized for having a trustee
rather than a fiscal agent - something many bondholders actually
welcome. On the other hand it receives no credit for closing the
loophole that allows such countries as Brazil and Mexico, if
they're feeling particularly nasty, to use exit consents to
brutally amend the payment terms on their CAC bonds.
"I think the Uruguay deal is quite clever, and it goes beyond
Mexico in providing investors protection against abuse," says a
sell-side analyst who wasn't involved in the deal. But the trade
associations clearly don't see it that way, and it is they who seem
to have persuaded Brazil that, on the one hand, Uruguay is
irrelevant as a precedent, and, on the other, that even if it were
a precedent, it would be a bad one to follow.