| Michael Chamberlin | ||||||
If bondholders’ unhappiness at the way they were treated in Pakistan, Ecuador and Ukraine boils down to the fact that they perceive that creditors’ rights were not respected, then the most egregious example of those rights being demolished came in the case of Ecuador, with the inclusion of exit consents in the exchange offer. Now that they have been used successfully once, there is a presumption among a lot of market participants that they will be used again. That makes the Emerging Market Creditors Association (EMCA), and others, extremely nervous.
Ecuador’s offer was richer than the market had expected – that was the carrot. But exit consents comprised a big stick. Every bondholder who tendered into the exchange was required to vote in favour of a long list of amendments to provisions in the original bond documentation, all of which made holding the original bond much less attractive. By the time the offer was finished, many of the rights written into bondholders’ documentation no longer existed.
The key to exit consents is that while 100% of bondholders are required to alter the payment schedule on a security issued under New York law, usually much less than that is sufficient to change other parts of the documentation.
Bondholders who accepted Ecuador’s offer were forced to agree to exit consents that deleted from the original bonds the requirement that all payment defaults must be cured as a condition to any recision of acceleration; the provision that restricts Ecuador from purchasing any of the Brady bonds while a payment default is continuing; the covenant that prohibits Ecuador from seeking a further restructuring of Bradys; the cross-default clause; the negative pledge covenant; and the covenant to maintain the listing of the defaulted instruments on the Luxembourg Stock Exchange.
Abigail McKenna, a fund manager at Morgan Stanley Asset Management and a leading light in EMCA, has nothing good to say about Ecuador’s tactics. “The unilateral use of exit consents à la Ecuador is a terrible precedent, and moreover it definitely hurts the asset class,” she says. “I think it will hurt other issuers if people believe that that will be a mechanism for restructurings going forward. Because those were so coercive.”
By the time most original bondholders had tendered into the exchange, Ecuador’s PDI Brady bond, the biggest and most liquid of the country’s debt instruments, was unaccelerable. Anybody holding it could not sue for repayment of principal until after maturity in 2024, even if the country never made a payment on it again.
“I think that exit consents up to a point are fair and reasonable,” says Michael Chamberlin, executive director of the Emerging Markets Traders Association. “Past the point, I think they become very unfair and coercive. When they scorch the earth, I think they stop making sense really fast. And I think that the Ecuador deal skirted with that boundary. Had they gone much further it would have been totally outrageous. As it was, I think it was on the boundary, maybe a little bit over the boundary.”
One or two of the consents, far from being coercive, were actually necessary if par and discount bondholders were to receive their collateral in full. But actions such as the removal of listed status were purely punitive actions designed to “render the old bond a less hospitable abode for prospective hold-outs”, as Lee Buchheit, a partner at law firm Cleary, Gottlieb, Steen&Hamilton, widely considered the author of the idea of sovereign exit consents, put it in a UCLA Law Review article in October 2000.
Ecuador actually went much less far in fact than Buchheit had proposed that a sovereign might go in theory. Two clauses in particular were left in the old Ecuadorean bonds that Buchheit had suggested might have been removed: the waiver of sovereign immunity, and the submission to foreign jurisdiction.
Removing the first would have made it much harder for creditors to attach the sovereign’s assets; removing the second could make it hard to sue the sovereign at all outside its own home turf.
Buchheit, in his article, says that it is perfectly reasonable and rational for a bondholder to agree to exit consents. “The proponent of the theory that lenders owe each other an implicit duty not to take actions that might injure or frustrate another lender might find that this argument proves too much,” he writes. “After all, if such implicit duties do exist, may not the majority lenders rely on them to force dissidents into accepting the judgement of the majority concerning an action such as a proposed amendment?”
Buchheit continues by writing that “through exit consents, the majority of creditors help to ensure that neither they nor the sovereign are exploited by a dissident minority of creditors. Importantly, this involves the financial community as a whole protecting itself against opportunistic behaviour by maverick elements, rather than the official sector intervening.”
Bondholders, unsurprisingly, are less keen on the idea. “Any investor who votes for retroactive change is a fool, because any degradation of creditors’ rights will ultimately redound to the detriment of every creditor,” says one. “The people who vote for changes in documentation retroactively are idiots. Because people who hold out are going to hold out no matter what.”
In the middle are such people as McKenna, who can appreciate the usefulness of exit consents, but only in the context of a negotiated solution. “There’s a majority action problem for everybody when you have a sovereign debt restructuring,” she says. “If you have a negotiated solution, then I think those who negotiated the solution would agree to exit consents to facilitate the workout which they’ve just agreed to. I have no problem with that. I don’t have a problem with the use of exit consents as a way around the majority action problem when the holders of the debt have been involved in the process.
What I do have a problem with is the unilateral use of exit consents, which I view as coercive, and a way for sovereigns to jam down a restructuring.”
There is an obvious solution to the dilemma of whether or not to use exit consents: the inclusion of majority action clauses. But such clauses, ironically, are themselves considered a form of jamming-down by Michael Corbat, a managing director at Salomon Smith Barney, who advised the Ecuadoreans. “I think that if majority action clauses were part of the covenant package of the new bonds, we would have been very hesitant about leading the charge,” he says. “We were very upfront with the Ecuadoreans and said we would not participate in any cram-down or forced restructuring.”
Majority action clauses are actually quite common in bonds issued under English law; Pakistan had them in its Eurobonds. They essentially allow a super-majority of bondholders to bring a last few percentage points’ worth of bondholders along with them, whether they disagree in principle, because they want to try their luck as free riders, or just because they aren’t aware that a negotiation is going on.
The opponents of majority action clauses tend to be the investment banks and the finance ministers of the emerging-market countries that would be asked to be the guinea pigs should an attempt be made to introduce them into bond documentation. Salomon Smith Barney’s Corbat thinks bond spreads would widen should majority action clauses be introduced; the most recent academic research indicates that would happen for low-rated borrowers, while spreads would actually narrow for borrrowers with good credit.
The official sector has advocated the inclusion of majority action clauses for some time, to the point where the UK actually took its own advice and included one in an international bond last year. And even the Institute of International Finance says that there could be a role for them.
Bondholders, for their part, tend to welcome the prospect of majority action clauses, provided that the super-majority is set high enough and that they have a say in the restructuring process. “People who’ve gone through any kind of restructuring process recognize the validity and attractiveness of having a solution which, when some large threshhold comes to that conclusion, can be applied to all creditors,” says EMCA’s McKenna. “You certainly wouldn’t want to give that flexibility, however, without in return getting some legitimate role in terms of a negotiating role in the process. I don’t think there’s any way creditors are going to agree to collective action clauses if they’re not guaranteed some legitimacy in the process. In a model where unilateral exchange offers are the end product, people are not going to agree to collective action clauses.”
If bondholders really wanted majority action clauses, they would have them already; the very fact that so few bonds carry them is indicative of the fact that the debate on the clauses is ultimately not very important.
After all, even if all new bonds were to include the clauses tomorrow, there would still be thousands of sovereign bonds out there that needed to be restructured without them. So the debate comes back to exit consents once again.
