Public Information Notice: IMF Board Discusses Collective Action Clauses in Sovereign Bond Contracts
IMF News, July 26, 2002
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- Published: July 26, 2002
Background
- Date of Board discussion: June 27, 2002.
- Context: Fund examining two complementary approaches to sovereign debt restructuring:
- statutory approach: amendment of the IMF's Articles of Agreement, or a new international treaty, to create a legal framework for orderly debt restructuring; and
- contractual approach: facilitate restructuring by enhanced use of certain clauses in sovereign debt contracts.
- Market practice as of discussion: collective action clauses are the norm for bonds issued in the United Kingdom; roughly 70 percent of all outstanding bonds have been issued in jurisdictions (mainly New York and Frankfurt) where the use of majority restructuring provisions is not yet the norm.
- Official sector since 1996 has encouraged use of collective action clauses (majority enforcement and majority restructuring provisions), but uptake in key jurisdictions remained limited.
Papers Considered by the Executive Board
- "Collective Action Clauses in Sovereign Bond Contracts—Encouraging Greater Use"
- Examined reasons for limited use of collective action clauses in key jurisdictions.
- Found variation in use largely, but not exclusively, due to market practice rather than national law requirements.
- Identified perception of first-mover cost borne by issuers adopting majority restructuring provisions where not market standard, despite no clear evidence of a price premium where clauses are standard.
- Explored Fund actions to promote use: more active bilateral and multilateral surveillance; making use of clauses a condition for access to Fund resources and/or special facilities; differentiating the rate of charge or repurchase periods.
- Explored external measures: engagement of investment grade emerging market countries and advanced economies to lead by example; financial enhancements by advanced economies; amending securities registration and listing requirements; engagement with major issuing houses and institutional investors.
- "The Design and Effectiveness of Collective Action Clauses"
- Assessed existing majority restructuring and majority enforcement provisions and several possible new provisions.
- Highlighted potential new provisions:
- representation clauses: authorize trustee or delegate to act as channel of communication between debtor and bondholders early in restructuring;
- initiation clauses: provide temporary protection against maverick litigation;
- aggregation clauses: aggregate creditor claims of different bonds for voting purposes.
- Noted important differences in market practice across issuing jurisdictions and mixed preliminary market reactions to innovative provisions.
Executive Board Assessment — General Conclusions
- Broad agreement that existing collective action clauses could aid orderly crisis resolution and provide predictability to restructuring.
- Complementarity noted between work on collective action clauses and the Fund's work on a statutory framework for debt restructuring.
- Anticipation of forthcoming discussion on Fund access policy as an important element of crisis prevention and resolution framework.
Design and Effectiveness of Clauses — Findings and Views
- Most useful clauses identified: majority restructuring and majority enforcement provisions found in many international sovereign bonds.
- Voting threshold viewed as critical; most Directors considered a 95 percent threshold — as recently proposed by an investor organization — would be excessively high.
- British-style trust deeds cited as containing an even more effective majority enforcement provision and could serve as a useful model; concerns noted about potentially higher costs of trust deeds.
- On innovative provisions:
- Representation clauses seen by several Directors as potentially contributing to orderly and speedy restructuring by establishing early communication channels.
- Initiation and aggregation clauses considered more difficult to design and implement given unclear features and mixed market reaction; progress not ruled out, particularly in relation to work on the Sovereign Debt Restructuring Mechanism.
Encouraging Greater Use — Analysis of Options and Director Positions
- Observed disappointment that official calls since 1996 had little impact on market practice, though recent private sector communications suggested growing support for restructuring clauses with high majority thresholds.
- Evidence on price effects inconclusive; available information suggested no significant price advantage to a particular governing law or jurisdiction.
- First-mover problem identified: issuers may face higher perceived costs adopting clauses where not market practice; once new practice established, additional costs likely limited.
- Fund actions most Directors supported:
- Encourage stronger use through multilateral and bilateral surveillance.
- Monitor use of clauses in new issuances and outstanding debt.
- Actions largely opposed or seen as problematic by many Directors:
- Conditioning access to Fund resources on use of collective action clauses in new bond issues — many Directors strongly opposed; some supported a presumption that countries seeking access would include clauses.
- Creating a requirement via amendment of the Fund's Articles — not supported.
- Creating a special Fund facility with lower charges or longer repurchase periods tied to inclusion of clauses — not supported on balance.
- Specific modalities discussed:
- Presumption for exceptional access: most Directors found implementation difficult.
- Conditioning Contingent Credit Lines (CCL) approval on use of clauses: most Directors felt this would reduce demand for the facility; some saw consistency with CCL's aim of promoting best practices.
- Conditioning willingness to lend into arrears on commitment to use clauses in a comprehensive restructuring: most Directors supportive as it avoids requiring non-defaulting countries to alter existing debt legal terms; others opposed due to acceptability and cost concerns and potential stigmatization.
- Withholding resources from members willing to implement strong adjustment programs but not adopting clauses viewed as difficult and potentially inappropriate linkage between clauses and macroeconomic program objectives.
- Introducing clauses in new issues only (rather than comprehensive exchange to retrofit outstanding debt) seen as more realistic due to excessive cost of retiring existing debt lacking clauses.
External and Market-Based Measures Considered Most Effective
- Consensus view: concerted external approach involving issuers, major issuing houses, and institutional investors to change market standards in key jurisdictions would be the least costly and most effective means of promoting use of clauses, though achieving such consensus might be difficult.
- Industrial countries leading by example considered desirable by many Directors, though practical effect uncertain.
- Exploring changes to securities registration and listing requirements in major jurisdictions to require collective action provisions viewed as potentially most effective but difficult given regulatory mandates and need for national legislation and coordination among financial centers to avoid regulatory arbitrage.
- Staff encouraged to continue exploring possible incentives for debt swaps and other measures that could promote adoption of collective action clauses.
Public Information Notice: IMF Board Discusses Collective Action Clauses in Sovereign Bond Contracts, July 26, 2002