## ppea2019008 ## Source details **Canonical URL:** [ppea2019008](https://www.imf.org/-/media/files/publications/pp/2019/ppea2019008.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2019/ppea2019008.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2019/ppea2019008.pdf.json) --- ### Introduction - The IMF Executive Board endorsed in October 2014 the inclusion of key features of enhanced pari passu provisions and collective action clauses (CACs) in new international sovereign bonds. - The Executive Board endorsement included: - a modified pari passu provision that explicitly excludes the obligation to effect ratable payments, and - an enhanced CAC with a menu of voting procedures, including a “single-limb” aggregated voting procedure, a two-limb aggregated voting procedure, and a series-by-series voting procedure. - Directors supported an active role for the IMF in promoting inclusion of these clauses. The IMFC and the G20 also called on the IMF to promote their use and report on inclusion. - Periodic progress reports found substantial progress: approximately 87 percent of new international sovereign bond issuances between October 2014 and September 2017 (in nominal principal amount) included enhanced clauses. - Reports found no observable market impact from inclusion of enhanced clauses, but noted a significant outstanding stock without enhanced clauses and limited appetite by issuers for liability management operations to accelerate turnover. - This paper provides an update on inclusion of enhanced clauses and suggests regular periodic updates can be discontinued because inclusion has become the norm. ### Enhanced Contractual Provisions — Collective Action Clauses (CACs) - Uptake of Enhanced Clauses (based on information as of October 31, 2018): - Around 510 international sovereign bond issuances since October 1, 2014. - Total nominal principal amount of approximately US$ 620 billion. - Approximately 88 percent of new issuances have included the enhanced CACs, compared with 87 percent as of end-September 2017. - From end-September 2017 to end-October 2018, only 8 percent of issuances did not include enhanced CACs. - Issuances under Chinese and Japanese law do not include enhanced CACs. - Remaining non-adopters (from end-September 2017 to end-October 2018): - The Bahamas and Lebanon under New York law. - Azerbaijan, Macedonia and Poland under English law. - Governing law breakdown (In percent of total issuances since October 2014): - English: No enhanced CACs 5.2, Enhanced CACs 45.1, Total 50.3 - New York: No enhanced CACs 5.2, Enhanced CACs 43.0, Total 48.2 - Chinese and Japanese: No enhanced CACs 1.5, Enhanced CACs 0.0, Total 1.5 - Total: No enhanced CACs 11.9, Enhanced CACs 88.1, Total 100.0 ### Enhanced Contractual Provisions — Pari Passu Provision - The endorsed modified pari passu provision explicitly states that the clause does not require the issuer to pay external indebtedness on an equal or ratable basis. - Since end-September 2017, all issuances that included enhanced CACs also included modified pari passu provisions, except for issuances by: - Bahrain, Indonesia (both sukuk), and Pakistan, and Russia under English law. - Some issuers that did not include enhanced CACs have included modified pari passu clauses in recent issuances (Azerbaijan and Macedonia under English law; Lebanon under New York law). - Euro area sovereigns have generally not included modified pari passu clauses. - While formulations vary, all modified clauses specifically disavow the obligation to make ratable payments. - Enhanced CACs and Modified Pari Passu (In percent of total issuances since October 2014): - No Modified Pari Passu: No enhanced CACs 7.3, Enhanced CACs 5.7, Total 13.1 - Modified Pari Passu: No enhanced CACs 4.6, Enhanced CACs 82.3, Total 86.9 - Total: No enhanced CACs 11.9, Enhanced CACs 88.1, Total 100.0 ### Enhanced Contractual Provisions — Market Impact - Empirical finding: inclusion of enhanced CACs does not seem to have an observable pricing effect in primary or secondary markets. - Over the last twelve months, yields at issuance of bonds with enhanced CACs are well aligned with relevant points on their sovereign yield curves for both investment grade and noninvestment grade countries. - In the secondary market, bonds with enhanced CACs did not exhibit noticeably higher yields, including during periods of market stress. - Recent empirical studies summarized in Box 1 find: - Inclusion of regular CACs generally contributes to lower bond yields, with a pronounced cost-reducing impact for lowly-rated countries during episodes of market stress. - Enhanced CACs also contribute to lower yields of noninvestment-grade issuers but without statistical significance. - Studies of European issuance show two-limb Euro CACs bonds trade at lower yields when sovereigns are more likely to be in distress and in countries with better legal systems; cost-reduction differs across European countries. ### Enhanced Contractual Provisions — Outstanding Stock - The outstanding stock of sovereign debt without enhanced CACs is declining slowly through attrition. - The share of international sovereign bonds that include enhanced CACs grew from 27 percent of the total outstanding stock as of end-September 2017 to 39 percent as of end-October 2018. - Maturity profile and risk: - About 31 percent of bonds without enhanced CACs will mature in more than 10 years. - About 50 percent of the bonds maturing in more than 10 years are below investment grade. - Close to 70 percent of the bonds maturing in more than 10 years are governed by New York law, which may pose risk of holdout behavior. - Sovereign interest in liability management operations to accelerate incorporation of enhanced CACs remains very limited, largely attributable to associated transaction costs. ### Bond Governance Structures - International sovereign bonds are typically issued under either fiscal agency agreements (FAAs) or trust structures. - FAA: fiscal agent acts as agent of the issuer; main responsibility is making principal and interest payments to bondholders. - Trust structures: a bond trustee acts on behalf of bondholders as a group and has additional responsibilities to bondholders. - Trust structures provide additional protection against holdout creditors, including: - limitations on individual creditor enforcement actions, and - pro rata distribution of litigation proceeds among all bondholders, which disincentivizes minority holders from disruptive enforcement actions. - Given these protections, a number of large emerging market issuers under New York law (e.g., Mexico and Chile) had switched from FAAs to trust structures. ### Trust structures and governing law - The total percentage of new international sovereign bond issuances since October 1, 2014 using trust structures is approximately 36 percent (in nominal principal terms). - Over 93 percent of those trust-structured issuances are issued under New York law. - Since October 1, 2014, 68 percent of new New York law issuances have used trust structures. - Ukraine is the only issuer to use a trust structure under English law since October 1, 2014. - The preference for fiscal agency agreements (FAAs) under English law may reflect that many lower income countries issuing under English law are more sensitive to the higher costs associated with trust structures. - Footnote context: The number reported in the 2017 paper (based on end-September 2017 data) was 42 percent. This number did not exclude sukuk, whereas the 2018 number does. All numbers reported in this section exclude sukuk. ### Other developments and policy direction - The Eurogroup announced broad support amongst euro area finance ministers to amend the ESM treaty to require single-limb CACs in all euro area issuances by 2022. - Currently, the ESM treaty requires the inclusion of two-limb and series-by-series CACs in all issuances by euro area members. - The inclusion of single-limb CACs would be a significant development in harmonizing market practice globally. - Staff actions going forward: - Continue to collect information on the stock of existing international sovereign bonds, including the use of CACs and pari passu provisions, residual maturities, and authorities’ intentions regarding future issuances. - Continue to engage on related issues with the membership through various fora. - Given that the inclusion of enhanced collective action clauses and modified pari passu provisions has become the market standard, staff proposes to discontinue annual progress reports on this topic. - Staff will continue to inform the Board of any significant developments in this area in the context of future papers on sovereign debt related issues. ### Data and notes on bond clauses - Pari passu clauses are largely incorporated as a package with enhanced CACs, with some exceptions. - Sources for the annex data: Perfect Information database and staff calculations. *International Monetary Fund — Fourth Progress Report (March 6, 2019)* ### INTRODUCTION _____________________________________________________________________ 3 ### ppea2019008 - INTRODUCTION _____________________________________________________________________ 3 ### Introduction - The IMF Executive Board endorsed in October 2014 the inclusion of key features of enhanced pari passu provisions and collective action clauses (CACs) in new international sovereign bonds. - The Executive Board endorsement included: - a modified pari passu provision that explicitly excludes the obligation to effect ratable payments, and - an enhanced CAC with a menu of voting procedures, including a “single-limb” aggregated voting procedure, a two-limb aggregated voting procedure, and a series-by-series voting procedure. - Directors supported an active role for the IMF in promoting inclusion of these clauses. The IMFC and the G20 also called on the IMF to promote their use and report on inclusion. - Since the endorsement, periodic progress reports found substantial progress: approximately 87 percent of new international sovereign bond issuances between October 2014 and September 2017 (in nominal principal amount) included enhanced clauses. - Reports found no observable market impact from inclusion of enhanced clauses, but noted a significant outstanding stock without enhanced clauses and limited appetite by issuers for liability management operations to accelerate turnover. - This paper provides an update on inclusion of enhanced clauses and suggests regular periodic updates can be discontinued because inclusion has become the norm. ### Enhanced Contractual Provisions — Collective Action Clauses (CACs) - Uptake of Enhanced Clauses: - Based on information as of October 31, 2018, there have been around 510 international sovereign bond issuances since October 1, 2014, for a total nominal principal amount of approximately US$ 620 billion. - Approximately 88 percent of new issuances have included the enhanced CACs, compared with 87 percent as of end-September 2017. - From end-September 2017 to end-October 2018, only 8 percent of issuances did not include enhanced CACs. - Issuances under Chinese and Japanese law do not include enhanced CACs. - Remaining non-adopters (from end-September 2017 to end-October 2018): - The Bahamas and Lebanon under New York law. - Azerbaijan, Macedonia and Poland under English law. - Governing law breakdown (In percent of total issuances since October 2014): - English: No enhanced CACs 5.2, Enhanced CACs 45.1, Total 50.3 - New York: No enhanced CACs 5.2, Enhanced CACs 43.0, Total 48.2 - Chinese and Japanese: No enhanced CACs 1.5, Enhanced CACs 0.0, Total 1.5 - Total: No enhanced CACs 11.9, Enhanced CACs 88.1, Total 100.0 ### Enhanced Contractual Provisions — Pari Passu Provision - The modified pari passu provision is largely incorporated with enhanced CACs, with some exceptions. - The endorsed modified pari passu provision explicitly states that the clause does not require the issuer to pay external indebtedness on an equal or ratable basis. - Since end-September 2017, all issuances that included enhanced CACs also included modified pari passu provisions, except for issuances by: - Bahrain, Indonesia (both sukuk), and Pakistan, and Russia under English law. - Some issuers that did not include enhanced CACs have included modified pari passu clauses in recent issuances (Azerbaijan and Macedonia under English law; Lebanon under New York law). - Euro area sovereigns have generally not included modified pari passu clauses. - While formulations vary, all modified clauses specifically disavow the obligation to make ratable payments. - Enhanced CACs and Modified Pari Passu (In percent of total issuances since October 2014): - No Modified Pari Passu: No enhanced CACs 7.3, Enhanced CACs 5.7, Total 13.1 - Modified Pari Passu: No enhanced CACs 4.6, Enhanced CACs 82.3, Total 86.9 - Total: No enhanced CACs 11.9, Enhanced CACs 88.1, Total 100.0 ### Enhanced Contractual Provisions — Market Impact - Empirical finding: inclusion of enhanced CACs does not seem to have an observable pricing effect in primary or secondary markets. - Over the last twelve months, yields at issuance of bonds with enhanced CACs are well aligned with relevant points on their sovereign yield curves for both investment grade and noninvestment grade countries. - In the secondary market, bonds with enhanced CACs did not exhibit noticeably higher yields, including during periods of market stress. - Recent empirical studies summarized in Box 1 find: - Inclusion of regular CACs generally contributes to lower bond yields, with a pronounced cost-reducing impact for lowly-rated countries during episodes of market stress. - Enhanced CACs also contribute to lower yields of noninvestment-grade issuers but without statistical significance. - Studies of European issuance show two-limb Euro CACs bonds trade at lower yields when sovereigns are more likely to be in distress and in countries with better legal systems; cost-reduction differs across European countries. ### Enhanced Contractual Provisions — Outstanding Stock - The outstanding stock of sovereign debt without enhanced CACs is declining slowly through attrition. - The share of international sovereign bonds that include enhanced CACs grew from 27 percent of the total outstanding stock as of end-September 2017 to 39 percent as of end-October 2018. - Maturity profile and risk: - About 31 percent of bonds without enhanced CACs will mature in more than 10 years. - About 50 percent of the bonds maturing in more than 10 years are below investment grade. - Close to 70 percent of the bonds maturing in more than 10 years are governed by New York law, which may pose risk of holdout behavior. - Sovereign interest in liability management operations to accelerate incorporation of enhanced CACs remains very limited, largely attributable to associated transaction costs. ### Bond Governance Structures - International sovereign bonds are typically issued under either fiscal agency agreements (FAAs) or trust structures. - FAA: fiscal agent acts as agent of the issuer; main responsibility is making principal and interest payments to bondholders. - Trust structures: a bond trustee acts on behalf of bondholders as a group and has additional responsibilities to bondholders. - Trust structures provide additional protection against holdout creditors, including: - limitations on individual creditor enforcement actions, and - pro rata distribution of litigation proceeds among all bondholders, which disincentivizes minority holders from disruptive enforcement actions. - Given these protections, a number of large emerging market issuers under New York law (e.g., Mexico and Chile) had switched from FAAs to trust structures. ### Other Developments and Next Steps - The paper reports that inclusion of enhanced clauses has become the norm for international sovereign bond issuances and proposes that future updates be prepared as needed rather than on a regular periodic basis. *International Monetary Fund — Fourth Progress Report (March 6, 2019)* ### 11. While trust structures continue to be prominent in international sovereign bonds ### 11. While trust structures continue to be prominent in international sovereign bonds ### Trust structures and governing law - The total percentage of new international sovereign bond issuances since October 1, 2014 using trust structures is approximately 36 percent (in nominal principal terms). - Over 93 percent of those trust-structured issuances are issued under New York law. - Since October 1, 2014, 68 percent of new New York law issuances have used trust structures. - Ukraine is the only issuer to use a trust structure under English law since October 1, 2014. - The preference for fiscal agency agreements (FAAs) under English law may reflect that many lower income countries issuing under English law are more sensitive to the higher costs associated with trust structures. - Footnote context: The number reported in the 2017 paper (based on end-September 2017 data) was 42 percent. This number did not exclude sukuk, whereas the 2018 number does. All numbers reported in this section exclude sukuk. ### Other developments and policy direction - The Eurogroup announced broad support amongst euro area finance ministers to amend the ESM treaty to require single-limb CACs in all euro area issuances by 2022. - Currently, the ESM treaty requires the inclusion of two-limb and series-by-series CACs in all issuances by euro area members. - The inclusion of single-limb CACs would be a significant development in harmonizing market practice globally. - Staff actions going forward: - Continue to collect information on the stock of existing international sovereign bonds, including the use of CACs and pari passu provisions, residual maturities, and authorities’ intentions regarding future issuances. - Continue to engage on related issues with the membership through various fora. - Given that the inclusion of enhanced collective action clauses and modified pari passu provisions has become the market standard, staff proposes to discontinue annual progress reports on this topic. - Staff will continue to inform the Board of any significant developments in this area in the context of future papers on sovereign debt related issues. ### Data and notes on bond clauses - As noted in the paper, pari passu clauses are largely incorporated as a package with enhanced CACs, with some exceptions. - Sources for the annex data: Perfect Information database and staff calculations. *International Monetary Fund — Fourth Progress Report (excerpt).* --- _Source: https://www.imf.org/-/media/files/publications/pp/2019/ppea2019008.pdf_