August 28, 2014 6:52 pm

New framework for sovereign defaults

epa04351184 Hundreds of supporters of Cristina Fernandez de Kirchner hold a rally at 'Luna Park' in Buenos Aires, Argentina, 12 August 2014. The rally was held to support the Argentine government in their dispute with a US hedge fund. Argentina is hoping to take a lawsuit against the USA to the International Court of Justice (ICJ) over US rulings concerning Argentina's 2001 default on its debt. EPA/DAVID FERNANDEZ©EPA

Hundreds rally in Buenos Aires over the Argentine debt crisis

A group representing more than 400 of the world’s largest banks, investors and debt issuers has agreed a plan for dealing with financially stricken countries and their creditors, in a bid to prevent a repeat of the wrangling that has pushed Argentina into default.

After months of talks convened by the US Treasury in the wake of Greece’s restructuring, global debt experts will on Friday unveil a new framework that could transform the relationship between critically indebted nations and lenders.

Lawsuits filed by creditors against defaulting governments have doubled over the last decade and the changes come at a time when levels of sovereign debt have risen to record highs around the world in the wake of the financial crisis.

The fallout from recent defaults reignited calls for an international bankruptcy court, but market participants and Washington authorities favour a voluntary response rather than new statutory mechanisms.

The International Capital Market Association, whose members include banks, investors and debt issuers, has created fresh clauses for inclusion in sovereign debt contracts that will give countries the option to bind all investors to decisions agreed by the majority.

The new approach will make it difficult for small holdout investors to undermine restructuring deals by giving countries the option to employ a single vote across all bonds, with a 75 per cent voting threshold, if it restructures its debt. This will hinder the chances of so-called “vulture” investors from buying up blocking stakes.

Alternatively governments can choose to take votes on each bond, or votes on individual bonds and a second vote across all debt. The final option has become a standard clause in eurozone government bonds since 2013 in the wake of the bloc’s debt crisis.

When Greece restructured billions of euros of debt in 2012 private investors with more than €6bn of Greek bonds would not accept the deal. Their actions put the country’s financial future at risk, say analysts, and set a precedent that threatened to discourage investors from agreeing to future restructuring deals.

A further change to be outlined on Friday is intended to make clear that the common “pari passu” clause, which hedge fund investors have used to argue for full repayment on Argentine debt, means equal treatments but not equal payments for bondholders.

While market participants have approved the idea, the next step would be for governments to start adopting the changes. Leland Goss, managing director of the ICMA, said countries might not adopt them immediately but that once one did, others were likely to follow quickly.

Recent bonds issued by countries in sub-Saharan Africa have cleaved to traditional wording, although bonds issued by Greece and Belize have clarified the pari passu clause.

Around half of all government debt defaults now trigger creditor lawsuits and in countries such as Congo, Ecuador, Iraq, Peru and Poland, small numbers of private investors have refused to take part in government plans to restructure unaffordable debt, holding out for full repayment.

“The existing bond contract architecture had faults in that holdouts could destabilise an agreement,” said Deborah Zandstra, a partner at Clifford Chance, the law firm.

Additional reporting by Robin Harding in Washington

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