On July 30 the country defaulted for the second time in 13 years, blocked from making $539 million interest payments on its debts until the protracted $1.5 billion legal dispute with hedge funds led by Elliott Management is settled.
There was some concern that if we went too far in favour of issuers it would impact pricing…
When private negotiations to resolve the dispute failed mid-month the price of Argentina’s 2033 notes fell to 80.17 cents on the dollar. The hedge funds locked in their acrimonious fight with the Latin American country have demonstrated not only the weakness in existing sovereign bond documentation but also the power of a small minority of investors to disrupt the restructuring process completely.
It was fortuitous timing, therefore, that the International Capital Market Association (ICMA) published revised and updated collective action clauses (CAC) and a new standard pari passu clause for sovereign debt securities at the end of the same month.
The Argentina dispute is based on the pari passu principle that bondholders should be paid the same, whether they accept the terms of a debt restructure or not. ICMA’s new pari passu clause disavows the ratable payment, removing the principle that holdouts and exchange creditors should be treated the same.
It also proposes aggregated CACs based on all bonds outstanding – limiting the potential for minority stakeholders to wield undue influence.
Leland Goss, general counsel at ICMA, agrees that the visibility of the Argentina case helped ICMA get the new clauses over the line. “The situation with Argentina has really come onto the front pages in the last two to three years,” he says. “However, the Greek PSI [which saw a CAC retroactively inserted into bond documentation] also really focused the official sector’s mind on the issue.”
Sovereign bondholders have traditionally viewed CACs as a trade-off: there is stronger protection against the risk of holdouts but at the expense of eroding creditors’ interests and rights. Borrowers tend to be very conservative about changing boilerplate language and will be reluctant to do anything to spook their investors.
However, Goss believes that many investors are in favour of the new clauses. “A large group of sovereign bondholders, who may buy at a discount, are knowledgeable and want to know that if there is a restructuring they can get out – they want to be “one and done”.
He believes that borrowers will support the proposals as well. “There was some concern that if we went too far in favour of issuers it would impact pricing but the introduction of the mandatory euro area model CAC in January 2013 had no pricing impact and we have not heard concerns that ICMA’s new clauses will impact pricing either,” he says.
Unsurprisingly, activist hedge funds have not been so enthusiastic. “Some hedge funds have argued that if you cut off the right to a ratable payment, you remove the discipline on the borrower to offer the best terms they can afford,” says Goss. “There are, however, other economic incentives for borrowers that assures that this discipline is maintained.”