LONDON/NEW YORK (Reuters) – Investors in emerging market sovereign bonds, concerned by restrictions on their debt restructuring options, are incorporating clauses into bond agreements that permit jurisdictional changes to bypass these limitations.
Recent debt arrangements, including one pending in Sri Lanka and another finalized last year in Suriname, feature provisions that allow investors to relocate the resolution of potential disputes.
These measures illustrate investors’ proactive stance against legislative changes that supporters claim would aid struggling countries in obtaining debt relief, but which financial firms argue could render emerging market bonds excessively risky or costly for borrowers.
“The proposed ideas are not going to disappear,” stated Andrew Wilkinson, a senior restructuring partner at Weil Gotshal. “They will continue to emerge because there is a genuine issue at hand.”
The proposed New York state law amendments, which impact approximately half of international bond deals, could limit commercial creditors’ recoveries to the levels of bilateral official lenders. Additionally, they might be subjected to a predetermined formula for determining entitlements in a restructuring scenario.
The intention behind these changes is to simplify the default process and reduce the burden of lengthy and costly negotiations for indebted nations. However, investors caution that they may be forced to accept losses that are manageable for government creditors but excessively burdensome for private ones.
“You will be imposing similar haircuts on lenders with vastly different reasons for extending credit,” warned Rodrigo Olivares-Caminal, a banking and finance law professor at Queen Mary University of London. “You are lending significant sums and have a fiduciary duty to your investors.”
Creditors also caution that proposals like those in New York could backfire, potentially deterring lenders from providing funds to poorer countries or prompting them to demand higher returns to compensate for the increased risk.
Although the New York bills have not passed in the past two years, support for legislative changes is growing on both sides of the Atlantic, amid what the World Bank describes as a silent debt crisis, with emerging nations facing external debt-servicing costs projected to reach $400 billion this year.
SLOW AND PAINFUL
A series of recent defaults, from Zambia to Ethiopia, has sparked debate over debt fairness, particularly as Zambia’s restructuring took three agonizing years.
Advocates for debt justice, such as Ben Grossman-Cohen, director of campaigns for Oxfam America, support the New York bills, describing the Sri Lankan contract clause as “merely an attempt to generate headlines.”
However, others, like Olivares-Caminal, see Sri Lanka’s bond provisions as a significant turning point.
“In Suriname, it was a minor technicality that went unnoticed. But Sri Lanka will likely send a strong message,” Olivares-Caminal remarked.
He noted that these clauses are a direct response to emerging challenges in New York and England, where similar proposals have gained traction since the Labour party’s rise to power.
In Suriname, negotiators added a clause permitting 50% of bondholders to request a jurisdiction change, with the country retaining veto power. Conversely, in Sri Lanka, just 20% of bondholders can initiate a vote to shift jurisdiction from New York to England or Delaware, with no veto right for the government.
NOWHERE TO RUN?
Even proponents of reforms aimed at making debt restructurings fairer for developing nations stress the need for careful legislative consideration.
Rebeca Grynspan, Secretary-General of the UN Trade and Development agency (UNCTAD), told Reuters that several provisions introduced over the past decade already safeguard against rogue creditors obstructing debt agreements in pursuit of better returns.
She highlighted that newer clauses, such as those for natural disasters, also serve to protect debtor countries.
“While legal instruments are crucial, excessive regulation may drive the private sector to seek debt issuance elsewhere,” she cautioned.
Shifting from New York law to English law would be relatively straightforward, according to restructuring experts, given that both jurisdictions have developed legal frameworks adept at managing sovereign debt defaults and their complexities.
However, transitioning to less established jurisdictions would pose challenges, according to Wilkinson of Weil Gotshal.
“You cannot simply create a restructuring regime from scratch and expect it to function,” he stated. “Established laws and experienced judges are essential for effective application.”