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Foreign Exchange

Pari passu clause is a threat to the markets

Recent cases involving sovereigns have shown how open to interpretation pari passu clauses are. Do they dictate equal payment to all similarly ranked creditors? If so, the international financial architecture faces a huge new risk.

THE FUTURE OF the international payments system is at stake, along with the smooth functioning of the Euromarkets and even the continued survival of the Bretton Woods institutions.

At the centre of this dispute is some of the most benign debt-contract language ever seen by anybody who has underwritten a Eurobond – the pari passu clause. It's a pretty standard feature of bond documentation. Yet if the clause means what some jurists say it means, there could be wide-ranging ramifications for the wellbeing of the international financial architecture. So much so that the US government has taken the rare step of filing a friend-of-the-court brief in a civil suit in New York.

The problems began in 2000, when Elliott Associates, a creditor of Peru, was seeking mechanisms to turn a New York court judgment against Peru into actual cash. Peru had ensured that it had no easily attachable assets in the US. But it did have Brady bonds issued there, and the bonds had coupons.

Elliott's argument, for all its novelty, was simple. All Peru's external indebtedness ranked pari passu in priority of payment. This meant that Peru couldn't pay some of its external bondholders without paying Elliott at the same time.

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