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Default rules in black and white

The prospect of sovereign bond defaults in emerging markets has focused attention on the legal documentation. Christopher Stoakes explains why.

Something curious is happening in the financial markets. The finer points of bond and loan documentation are usually the preserve of those bankers responsible for execution, in-house lawyers and the law firms that advise them. Rarely does the debate attract wider interest. But in the wake of recent sovereign bond defaults, there have been calls for changes in the underlying documentation to facilitate the restructuring process.

The reason for this is not hard to fathom. In the 1980s, when the modern approach to sovereign debt restructuring became established, most of the debt affected consisted of commercial bank loans. The structure of the syndicated loan with its agent bank and clearly identifiable syndicate members provided a framework by which creditors could, through a bank steering committee, establish a dialogue with the borrower.

In the 1990s, however the source of emerging-market funding switched from the loan market to bond markets. The international bond markets are - despite electronic registers held by the likes of Euroclear and Cedel - still characterized as bearer markets. Bond holders are not readily identifiable nor do they have or seek the same degree of intimacy with the issuer that a commercial bank has with its borrower.

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