Jay Newman was a senior portfolio manager at Elliott Management and is the author of the financial thriller under money. Matthew D McGill is a partner in the international law firm Gibson, Dunn & Crutcher, specializing in claims against sovereign governments
In documentary film Waiting for Superman, educator Geoffrey Canada describes his heartbreak when, as a fourth-grade kid living in a New York ghetto, he realized that Superman wasn’t real, that no one would come to save him. He should be saved.
Sovereign debt investors need to learn a lesson from Canada’s epiphany. If, as widely expected, Sri Lanka’s recent default predicts a wave of crisis and emerging market debt restructuring, creditors will suffer some violent shocks.
Unlike previous debt crises, this will bring two major new challenges.
First, the terms of most sovereign bond contracts have been so dramatically degraded over the past 20 years that the bonds have become functionally inapplicable. Among other challenges, creditors will face the prospect of working through a thicket of onerous collective action clauses that will allow debtors to manipulate restructuring negotiations.
But even more threatening for the recovery of values is the fact that this will be the first debt crisis in which China holds the whip. Since 2014, Chinese institutions have become a major lender and investor in over 130 countries through the mercantilist One Belt One Road (OBOR) initiative. Those bills are about to expire.
Despite the recent and breathless announcement that China will cooperate with the G-20 and the IMF to restructure Zambian debt, there is no objective indication of China’s true intentions towards Zambia, much less elsewhere. Historically, China has been reserved about the extent and terms of its relations with countries that owe it money. It is imperative that OBOR transactions are fully and transparently integrated into restructuring – and Chinese interests are explicitly bailed out – to protect the interests of all others.
Predictably, debtors will seek very high levels of forgiveness to reduce their debt service obligations to sustainable levels. It is one thing to agree to forgive the capital, reduce coupons and extend the maturity in the name of debt sustainability. But it is quite another thing to remain fatalistic on contractual terms which do not guarantee that the restructured debt is actually paid on its terms.
The case in question is Argentina. In 2020, Argentina’s creditors were asked – and they did – to accept incompetent contractual terms even though they provided substantial debt relief. Now, less than two years later, Argentina has not embarked on the structural economic reforms deemed necessary to manage even this newly reduced debt, much less the $ 40 billion it owes to the IMF. As Argentina reviews its third economy minister in just one month, bond prices imply that another international debt default, Argentina’s ninth, is on the horizon.
What can be done?
If creditors are serious about negotiating durable restructurings that will avoid the economic and social trauma of endless cycles of insolvency and litigation, it is time to insist on contractual terms that are significantly different from what we have now. It’s time to insist on tools that are executive: a Superbond.
A strong bond agreement, which offers creditors a wide range of legal safeguards and avoids many of the vagaries of current enforcement efforts, would make future restructuring significantly less likely and structurally lower the cost of capital for sovereign borrowers. Borrowers, recognizing that the playing field has been leveled to offer lenders effective legal remedies, may think long and hard about getting into more debt than they can comfortably repay, and they may be making tough policy choices to ensure their debts are timely repaid and sustainable. And, precisely because a Superbond would be more likely to be repaid than lower contracts, a Superbond would trade better on the secondary market.
So what are the critical elements of a Superbond? In many cases, return contracts to the status quo ante.
At the time of the syndicated bank loan to sovereigns, banks insisted on full fiscal transparency and conventional lending agreements, such as debt service ratios and overall debt limits. Today’s bondholders should ask for nothing less. Two other deals are vital as OBOR loans threaten to unwittingly subordinate other lenders.
A strong pari passu clause, provided that the payment obligations under the restructured bonds are not legally or practically subordinated to other debt obligations, is essential to ensure that the restructured bonds are not treated less favorably than the debts owed. to Chinese lenders and investors. The other is a robust negative commitment clause that prohibits debtor nations and their instruments from pledging sovereign assets as collateral or source of repayment to certain preferred lenders. This is what happened in 2017 when Sri Lanka was forced to cede the port of Hambantota to Chinese interests. And it could happen on a larger scale if Pakistan ceded Gilgit-Baltistan to China to offset its debts. If private creditors are asked to restructure claims against Sri Lanka, Pakistan, Lebanon, Zambia or other nations, they will need a Superbond to avoid being unwittingly subordinated to Chinese interests.
The application of these agreements will require transparency and information rights. But, as will soon be demonstrated in the Zambian case, the IMF and G-20 are intent on dictating conditions to private lenders: presenting them with a fait accompli, rather than giving them a seat at the table. This kind of behind-the-scenes deals echoes one of the most problematic aspects of OBOR. China has insisted on strict confidentiality of its loan terms, leaving other creditors in the dark about the borrower’s true financial condition. Even now the Sri Lankan government cannot say for sure how much of its $ 51 billion debt is owed to China.
Conversely, a Superbond would require debtors to be fully accountable for all of their debt obligations and involve the private sector in the whole process, without exception. This is the only way to get the tax house of any country in order.
Finally, there must be means to enforce these strengthened agreements and the underlying payment obligations in court. The rights of bondholders to enforce their contracts have been steadily eroded in recent sovereign bond contracts. no longer The right of bondholders to take direct legal action must be restored; Bondholders should not simply proceed through an indenture trustee.
In fact, with a Superbond, the violation of key covenants would be independently prosecutable, even before a non-payment. The Superbond would have a complete waiver of sovereign immunity with respect to the sovereign and all instruments of him. The sovereign would also agree never to assert such immunity from his debts and, perhaps, reinforce that promise with a surety equal to, say, 10 percent of the principal amount. An obligation could incur payment of damages settlement if the disingenuous ruler violates its “do not assert” obligations. And since a sovereign’s assets can typically only be seized if used for commercial activities, the Superbond will require sovereigns to stipulate that properties located outside the state are, by definition, commercial, unless they are used solely for diplomatic or military purposes. Last but not least, a debtor’s central bank should guarantee sovereign debt and waive immunity in both the jurisdiction and its assets, anywhere in the world, including funds in the hands of the Bank for International Settlements and the Federal Reserve. from New York.
The inhabitants of the sovereign debt ecosystem – lawyers, G7 bureaucrats, experts, IFI – will find these ideas anathema. But here’s the problem: either you mean a contract to be enforceable or you don’t. In the first case, non-compliance should lead to liability, not easy exits, fraudulent use of proceeds or optional compliance with covenants.
Of course, there is a huge practical impediment to the creation of a Superbond: the inability of the lending class to rally around these ideas – and to exercise the only undeniable power that remains: collective action.
Sovereign debt investors have the power to convert a vicious cycle of lending, defaults and restructuring into a virtuous one. The 50-year experiment of private sector hard currency lending to low-income countries was a failure. As defaults proliferate, Churchill’s admonition comes to mind: A good crisis should never go to waste. In the next crisis, creditors can fundamentally change the relationship between the private sector, sovereign borrowers, the official sector, IFIs, and even help unwitting borrowers find a way out of the mercantilist OBOR debt trap. If only creditors can find the collective will.