Over the last few months, governments from Kazakhstan to Mexico have quietly started changing the way they issue debt. These shifts—small tweaks in the way bond contracts are written—have received little attention, yet they have the potential to make future financial crises a lot easier to resolve. That means smaller losses for investors and less hardship for citizens.
These reforms are the result of new templates for sovereign bond contracts, which were released in August 2014. The templates were written by the International Capital Markets Association (ICMA), and the changes come after years of low-key consultations convened by the US Treasury Department between investors, banks, and policymakers. They contain two big changes: First, they make it simpler for a super majority of a government’s creditors—usually 75%—to agree on a restructuring and to impose a haircut on any uncooperative bondholders holding out for a better deal. Second, this improved legal boilerplate ensures that any holdouts can’t intervene to stymie or skim off future payments on this restructured debt. The net effect: improved incentives for creditors to avoid over-lending to suspect sovereigns, and to bargain fairly when these bets go bad.
The recent debt debacles in Argentina and Greece are very much behind these changes.
Following its 2001 default, Argentina has been pursued by a small band of hedge funds that refused to go along with the draconian terms the Kirchner governments stuck to bondholders in the 2005 and 2010 restructurings. Last June, these hedge funds—which the Argentines call “vultures”—won a landmark judgment in New York. Federal District Judge Griesa ruled that Argentina could not service the debt it restructured unless it also paid the vultures on their unrestructured bonds’ more lucrative terms. Buenos Aires decided to default on its restructured bonds rather than send a dime to the vultures.
This was a bad precedent: it implies that a single bondholder can, even years later, tear apart a carefully negotiated debt workout. While no contract is entirely impervious to enough clever and determined lawyers, ICMA’s new bond language explicitly tries to rule this out.
Greece also hit major snags in its 2012 restructuring. In half of its domestic bond issues, speculative investors were able to amass holdings large enough to prevent a super majority from endorsing a restructuring. Rather than delay the broader deal, these holdouts got paid in full using IMF and European public money. Hedge funds won; taxpayers footed the bill. Future restructurings would avoid this snag by taking a single vote across all bond issues rather than within each series individually, making a blocking minority harder to assemble.
In October, the International Monetary Fund (IMF) discreetly endorsed ICMA’s new bond language, which is pretty much the international finance world’s equivalent to a Good Housekeeping Seal of Approval. The Fund had earlier dismissed worries that the new legalese would unfairly favour debtors over the rights of creditors. In a landmark 2013 policy paper, the IMF noted that countries generally don’t default gratuitously on their debts. Instead, cash-strapped politicians, afraid for their jobs, tend to put off any acknowledgment that they have a financial problem. When they finally do move to restructure their debt, they rarely ask for enough relief to put them back on a stable footing—thereby paving the way for their next crisis.
The ink was barely dry on the IMF’s endorsement when, in October, unlikely Kazakhstan became the first country to issue bonds featuring a version of the ICMA-recommended language. Mexico, Vietnam, and Ethiopia all followed, and more are on the way. Demand for these new bonds has exceeded supply in each issue. Private investors haven’t blanched at the curbs imposed on creditor rights: they’ve welcomed the prospect of increased legal certainty.
It’s a pity, then, that this quiet revolution hasn’t received more attention. Seemingly oblivious to it, the United Nations’ General Assembly went ahead with a September resolution calling for the creation of an international bankruptcy court for countries. Never mind that this court won’t be needed if these new-style bonds live up to their promise: the UN resolution is largely a vehicle for Argentina, Venezuela and a few diplomats to air their grievances with global capitalism. Moreover, this court will never be created: the United States and United Kingdom won’t put London and New York markets under the thumb of a UN insolvency process.
Nevertheless, the contrast between the hoopla surrounding the UN resolution and the smooth sale of these new bond issues underscores an old truth: the most effective reforms are often so discreet, so aligned with various stakeholders’ interests, that they’re barely noticed until long after they’ve been done.