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Sovereign restructurings ahead with EM “whipsaw”

May 8, 2014

A lull in EM sovereign debt restructurings is set to end — but developed markets are not safe either, warns government bond expert Lee Buchheit

  Lee Buchheit  Source: IMF  
Sovereign borrowers in emerging and developed markets are set for trouble as global interest rates normalize, Cleary Gottlieb partner Lee Buchheit said on Wednesday.
"The relative paucity of debt restructurings in the emerging markets in the last five years has bred a degree of complacency," he told a Cleary Gottlieb seminar. "You see almost weekly now countries coming to the international capital markets that have never been there before or, if they had been there before, left under a malodor."
Emerging market sovereigns will come under "considerably more pressure" if interest rates rise at the same time as commodity prices fall, he said: "Those two things, if they happen simultaneously, will whipsaw a number of emerging markets. And so we will see that phenomenon of EM sovereign debt crises be renewed."
Developed market sovereigns were also at risk, he warned, noting that their debt stocks were "considerably larger" than before the global financial crisis was ignited in 2008. While low interest rates have allowed those borrowers to service that debt until now, they could come under "great pressure" as rates go up.

CACs change shape
An innovation in bond documentation could make sovereign restructurings more straight-forward, however, Buchheit said. Collective action clauses (CACs) in sovereign bonds are being changed, to cut the risk of holdout creditors disrupting a restructuring.
CACs minimize the chances that a small group of creditors can avoid a haircut taken by others in a restructuring — they stipulate that if a large majority of bondholders agree to a change the terms of a bond, that change will apply to the whole instrument. Now CACs are set to get even tougher for creditors.
"[CACs] do not work perfectly — they operate only bond by bond," Buchheit said on Wednesday. "The perception is that a well-advised holdout creditor with a relatively small investment can obtain a blocking position in one of those bonds.
"The innovation that you'll see are aggregated collective action clauses, in which bondholders don't vote bond by bond. They vote as they do in Chapter 11 — as a class. So all of the bondholders vote together and if a supermajority of the class decide to go ahead, then it binds everyone else."
The change was provoked by a small group of creditors pooling together to block changes on some Greek sovereign bonds when the European country restructured its debt, said Buchheit.
The US Treasury, the IMF, IIF and ICMA are working on proposals to change CACs in sovereign debt, Buchheit said. LF

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