Questions of seniority and majority
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Questions of seniority and majority

As the risk of a round of sovereign bond rescheduling looms, bondholders are dusting off the documentation to see what it says. By Christopher Stoakes

Last time the financial community had to deal with widespread sovereign bond defaults was in the 1930s. Today, bonds represent a significant part of the external debt of many emerging-market countries. Ecuador's alarm call last month renewed fears of multiple sovereign defaults.

Exposure to such risk has prompted weird talk of sovereign bondholders somehow being treated as senior creditors and therefore being entitled to preferential treatment. The reasoning seems to be that bondholders are portfolio investors and are at one remove from the borrower, whereas commercial bank lenders are able to scrutinize a borrower's credit standing more accurately; moreover, widespread default in the bond markets might create systemic havoc - since the holders of bearer instruments are dispersed far and wide, making any rescheduling exercise difficult to coordinate.

Legally, the idea that a bondholder is a senior creditor is hogwash. All creditors rank equally unless they hold security (over a part of the borrower's assets which entitles them to a preferential claim to that part). All major financings have a stipulation that the lenders must rank at least pari passu (equally) with other unsecured and unsubordinated creditors (this is achieved by a combination of pari passu and negative pledge clauses).

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