AFTER MANY YEARS of noisy and contentious debate about mechanisms for restructuring the bonds of troubled emerging-market sovereign debtors, matters came to a head in April. Mexico retired the last of its dollar Brady bonds and issued $2.5 billion in new global bonds with collective action clauses (CACs). Uruguay announced that it was looking to issue billions of dollars of new bonds with CACs, as part of a restructuring effort. And in the US, Treasury secretary John Snow administered the coup de grâce to the IMF’s plans for an international sovereign bankruptcy court enshrined in international law.
The reaction to these events was astonishing: nothing happened. Press conferences weren’t called, outraged op-ed columns didn’t run, the beginning of a new era in crisis resolution was not proclaimed. Admittedly, there was a small war on at the time. Even so, the equanimity with which this new world order was accepted stood in stark contrast to the ferocity of the debate surrounding its inception.
Uruguay’s use of CACs seems to have set a precedent for making them standard practice. Chilean finance minister Nicolas Eyzaguirre, for example, says that “countries with investment-grade ratings benefit from CACs without paying an extra amount”, which seems like a clear statement that if and when Chile comes to market again, it will include CACs in its bonds. Henrique Meirelles, president of the Brazilian Central Bank, says: “Brazil has favoured it for a long time” – a sentiment, it must be said, that was wholly invisible to the outside world up until extremely recently – “and our position is that everyone is moving towards that direction”. It seems Brazil is looking to jump on the bandwagon as well.
And Uruguay has now become only the second country ever to attempt to use a tool known as exit consents in trying to restructure its bonds. The first time this happened, in Ecuador in 2000, the uproar from the investor community was so great that it sparked the formation of a new trade organization – the Emerging Market Creditors Association (Emca). But in the case of Uruguay, Emca couldn’t even muster a mildly disapproving press release.
That is partly because Uruguay had bent over backwards to address bondholders’ concerns. Many Emca members were furious when in February Mexico issued its sovereign bonds with CACs because there was little if any consultation. Mexico announced that it was going to do a deal on the Monday, and the bonds were issued two days later, on the Wednesday. Many clauses the investor community had wanted were absent from Mexico’s documentation.
But anybody who owned Mexican debt and who opposed the introduction of CACs could simply stay away from its latest bond deals without causing harm to anyone.
In Uruguay, however, the situation is completely different. The country and the IMF have both made it clear that if Uruguay’s foreign debt can’t be reprofiled the bonds will have to go into default. And in order to reprofile the debt Uruguay needs the consent of the overwhelming majority of its bondholders. If, however, there were many Uruguayan bondholders adamantly opposed to CACs, the country could be forced to default.
Investor-friendly gestures
So Uruguay embarked on an extensive consultation process with its bondholders, and ended up with clauses much closer to those that the private sector had originally requested. The first major change involved a move to the trustee system of structuring bonds; while most bonds these days are structured with a fiscal agent, Uruguay has chosen the costlier but more investor-friendly system. Fiscal agents are agents of the borrower, whereas a trustee is an agent of the investors; this can make a world of difference in cases such as Ecuador’s, where bondholders found it incredibly difficult to vote to accelerate the country’s debt.
If Uruguay ever wants to alter any of its bonds it has to provide bondholders, via the trustee, with all manner of macroeconomic information, including any IMF memoranda and proposed treatment of other creditor groups.
This disclosure clause was dismissed by Mexico as unnecessary but it reassures investors and could well become a standard feature in new sovereign bond documentation as increasing numbers of countries start introducing CACs into their bonds.
There are two big questions about future bonds with CACs – one that Uruguay has raised, and one that it has answered. The answered question is that of the threshold: the percentage of bondholders that need to vote in favour of a change in payment terms. Until now, New York-issued bonds have had a 100% threshold. Mexico’s new bonds, issued in February had 75%, which upset bondholders, who generally wanted 85% or 90%. Uruguay, despite being in a much weaker position than Mexico, also plumped for 75%, which means that any country following in its footsteps is likely to do likewise.
Bondholders now seem to have conceded that this particular battle has been lost, although they’re not very happy about
it. One high-profile bondholder says that there were two reasons why Uruguay went with a 75% threshold rather than
something more investor-friendly.
The first, he says, is that “the US Treasury wants 75%, and they [Uruguay] want to stay on good terms with the Treasury.” After all, the US essentially controls IMF disbursements, which, in the case of Uruguay, are likely to be large. Secondly, he says: “Much of the Uruguayan debt is held by locals, so it’s easier to get the deal done.”
Certainly, Uruguayan bonds always sold well in the primary market because of a strong local bid. As the credit deteriorated, a lot of those bonds will have found their way back to Montevideo, where bondholders are likely to go along with what their
government is asking them to do.
There’s one other reason why Uruguayan bondholders might not care as much as, say, Brazilian bondholders about CACs. “CACs are basically irrelevant to the people who are going into this transaction, who are all basically flippers,” says Walter Molano, chief economist at BCP Securities. Uruguayan debt is trading at distressed levels, which means that many of the big institutions have sold to hedge funds looking for a high-risk, high-return, short-term investment. If Uruguay gets a single-B credit rating back upon successful completion of the exchange, the hedge funds will exit their investments, and sell the bonds – with their CACs – to someone else.
So in a sense it’s bad for international bond investors that the first two countries to adopt CACs both had the ability to set 75% thresholds. But that’s the way it worked out, and now that number is a generally acknowledged standard.
But the question of aggregation remains. Mexico didn’t have it: if it ever tries to restructure its bonds with CACs, it’s going to have to do so on a bond-by-bond basis, and people who vote on one bond will have no idea whether or not the rest of the
country’s bondholders will be similarly well intentioned.
Uruguay, on the other hand, does have aggregation: if it wants to restructure two or more bonds at the same time, it needs 85% of the aggregate vote and at least two-thirds of each bond to vote in favour. At this point, no-one really knows which way other issuers, such as Chile, Colombia or Korea, might jump.
Bizarre quirks
Aggregation is unpopular among some bondholders because it leaves open the possibility that holders of long-dated bonds will vote to restructure short-dated bonds. Uruguay’s clause saying that each bond needs two-thirds approval helps to avoid that kind of thing, but there are still a couple of slightly bizarre quirks to the Uruguayan system.
The main quirk is that if holders of one bond vote against a restructuring (that is, less than two-thirds of them vote in favour) then although that bond is then removed from the restructuring, the votes in favour still count towards the aggregation. So if holders of one particular bond are sure that they will have at least 34% votes against the restructuring, suddenly it’s in their best interest to vote for the restructuring – since that way everybody else could get restructured, while they can hold out for better terms at the end. Just as with exit consents, bondholders would be voting not to benefit themselves directly, but rather to weaken the relative position of other bondholders.
More important, an aggregation clause is open to abuse. At the extreme, Uruguay could sell, say, $200 billion in face value of zero-coupon 100-year bonds to a local pension fund, which would then vote for a huge restructuring of all outstanding debt. Since the pension fund would, on its own, have more than 85% of the total bonds outstanding, it could singlehandedly impose a restructuring on all other holders.
Uruguay has put three clauses into its bonds trying to assure investors that such behaviour is not going to happen. The first stipulates that every individual bond needs to vote two-thirds in favour of any aggregated restructuring. The second is a beefed-up version of a clause that Mexico had, defining which bonds would be considered outstanding for voting purposes. Both countries explicitly exclude any bonds owned or controlled by the government, although bonds held by government-regulated (but not government-owned) pension funds are still eligible to vote.
In the case of Uruguay, unlike Mexico, the central bank has an obligation to provide the trustee of the bonds with a list of all bonds owned by the government and by entities under its control.
The third clause says that Uruguay will not issue or reopen any bonds “with the intention of placing such debt securities with holders expected to support any modification proposed by Uruguay, or that Uruguay plans to propose”.
One lawyer says that “it’s hard to see how that clause would be enforceable, except in the most egregious cases: it’s more a token of good faith, but there’s no other way of doing it”. Even so, it’s better than nothing.
Of course, none of these new bonds, with their new clauses, exists as yet. Before they can be issued, Uruguay has to persuade 90% of its bondholders to change their clothes, as it were: to exchange their present bonds for longer-dated securities complete with CACs.
Uruguay’s exit consent
In order to do so, Uruguay has had to use a certain number of exit consents. The exit consents are weaker than those used by Ecuador were, although there is still a limited repeal of the waiver of sovereign immunity. It’s not clear whether that is strictly necessary, although Uruguay would like it, to make it much more difficult for holdouts with the present bonds – opposing the exchange – to win a court case in an attempt to claim the coupons paid out on the new bonds.
One relatively uncontroversial exit consent is the deletion of the cross-default and cross-acceleration provisions in the existing bonds: Uruguay wants to be able to default on the holdouts if it has to without triggering a new default across all its new bonds.
But the most innovative feature in Uruguay’s exit consents is what is known as the check-the-box provision. Many bondholders are steadfastly opposed to all exit consents at all times, and so Uruguay has allowed any of its bondholders that are so inclined to enter into the exchange without voting for the exit consents. Most bondholders that tender into the exchange, of course, will vote for the exit consents all the same: they don’t want to do any favours to people staying behind in the existing bonds.
There seems little doubt that if Uruguay gets the requisite 90% bondholder approval in aggregate, it will get at least 50% of bondholders to vote in favour of the exit consents. But these exit consents are “light years away from Ecuador,” says Mitu Gulati, a professor at Georgetown University Law Center who has written many papers on the subject. They’re much milder and less coercive.
In any case, as the resident expert on sovereign restructuring at a major bank says: “People like exit consents if the deal is fair” – they help to assure that they’re not going to come out second-best among bondholders, with holdouts getting paid
in full.
In general, Uruguay is being as good a borrower as it possibly can be. Bondholders appreciate that: they know that a country’s bargaining position is improved immensely if it negotiates from a position of default rather than trying to solve its problems without ever defaulting.
At the moment, Uruguay’s bondholders are receiving their coupons in a timely fashion and if they enter the exchange they’ll be giving that up in return for a higher likelihood of being repaid in full eventually. If Uruguay had defaulted already, instead of losing coupons the bondholders would be gaining them if they accepted an exchange offer. That’s a huge difference.
It’s that goodwill that probably best explains the lack of complaints from bondholders on the subject of the Uruguayan exchange. Uruguay was an investment-grade country only 15 months ago, and has all the institutions of a very strong emerging-market nation. Such institutions are generally severely damaged by default, and it’s clearly in everybody’s best interest to preserve them. So the exchange will almost certainly happen, and Uruguay will buy itself some time to rebuild before the big amortizations come due. Everybody will be hoping it succeeds.
