Collective Action Clauses: Recent Developments and Issues
Documents Related to the International Monetary and Financial Committee (IMFC) Meeting
||Progress Report to the International Monetary and Financial Committee on Crisis Resolution
September 28, 2004
1. In its recent Communiqué, the International Financial and Monetary Committee (IMFC) welcomed the inclusion by an increasing number of countries of collective action clauses (CACs) in their international sovereign bonds and the convergence toward a market standard.1 It called on the Fund to continue to promote progress in this area, and encouraged sovereign debtors and private creditors to continue their work on a voluntary Code of Conduct. The IMFC looked forward to reviewing further work on issues of general relevance to the orderly resolution of financial crises, and called on the Fund to continue reviewing the implementation of its lending into arrears (LIA) policy.
2. Against this background, this report focuses on crisis resolution initiatives under the existing legal framework. Section II describes progress in the use and design of CACs and efforts being undertaken by the Fund and others to encourage the use of CACs in international sovereign bonds.2 Section III reports on recent efforts by sovereign debtors and their creditors to develop a voluntary Code of Conduct (the "Code") applicable to both. Section IV reviews the application of the Fund's LIA policy in some recent cases. Section V provides an update of progress in the Paris Club's Evian Approach. Section VI presents a brief update of issues relating to litigation against sovereign debtors, and Section VII concludes.
II. Collective Action Clauses
A. Developments in Market Practice
3. Since March 2004, when the last progress report was finalized, sovereign issues containing CACs increased. They currently represent more than 90 percent of total value of bonds issued since that date, and 41 percent of the value of the outstanding stock of bonds from emerging market countries as of September 23, 2004 (Tables 1 and 2). This largely reflects the increasing number of sovereign bonds issued under New York law that contain CACs, including a large exchange offer by Mexico in April 2004, which replaced several outstanding series without CACs with new bonds containing such provisions.
4. Since March 2004, several emerging and mature market countries have continued to include CACs in their international sovereign bonds.
5. Market acceptance of CACs has continued with no observable impact on pricing even after international liquidity conditions toward emerging market debt gradually tightened in the second quarter of 2004. As has been the case during the past year, market reports on new sovereign bond issues are not focusing on the inclusion of CACs in bonds issued under New York law, reflecting the broad acceptance of CACs as market practice.
B. Design of CACs in Recent Issues
6. Since mid-2002, the Executive Board has repeatedly encouraged the inclusion of CACs in international sovereign bonds and, in particular, in those governed by New York law. While recognizing that any decision concerning the design of CACs will ultimately be made by the issuer and its creditors, Directors considered it appropriate to continue existing practice in the London market and encouraged the use in New York law bonds of CACs that are broadly in line with the provisions recommended by the G-10 Working Group.6 They recognized, however, that it was too early to reach a definitive view on the degree of standardization in terms of the design of CACs within and across jurisdictions. Table 3 contains a summary of the CACs contained in New York law bonds issued since March 2004 and a comparison of these provisions with the G-10 recommendations.7
7. Staff has continued to take a proactive role in promoting the inclusion of CACs in international sovereign bonds encouraging their adoption both in the context of the use of Fund resources and Article IV consultation discussions. Staff continues to maintain an active dialogue with private market participants and debt managers from a number of emerging market countries to further discuss the design of CACs and promote their use, including through the Forum for Public Debt Managers.
8. The G-10 Deputies Group has continued its efforts to promote and monitor developments in the use of CACs. Most recently, the Group discussed a report prepared by the Bank of England reviewing the progress that has been made in introducing CACs in international sovereign bonds and the scope for further engagement with issuers and market participants.13 The G-10 Deputies intend to report on their stocktaking in the meeting of the G-10 Ministers and Governors on October 3. Staff will inform the Executive Board of the deliberations of the G-10 Ministers and Governors on this matter.
9. The International Primary Market Association (IPMA), a group of market participants, together with six other trade associations, are leading an effort to define a market standard for CACs that reflects current best practice and is mutually acceptable to issuers, investment banks, and investors. Staff will provide the Board with a commentary should such a standard be agreed.
10. In its recent Communiqué, the IMFC encouraged sovereign debtors and their private creditors to continue their work toward developing a voluntary Code of Conduct. Recent experience in crisis countries suggests that debtor-creditor dialogue is critical to the success of the debt restructuring process. A Code could, in principle, facilitate dialogue between creditors and debtors, promote corrective policy action to reduce the frequency and severity of crises, and improve the prospects for an orderly and expeditious resolution of crises. For this reason and because the effectiveness of voluntary rules of conduct hinges on its acceptability to those most affected, this effort is best led by sovereign debtors and their private creditors. In this context, the experience with the introduction of CACs, which followed the same approach, is encouraging.
11. Building on work undertaken in the spring, efforts to develop a Code are continuing in both the G-20 and the Institute of International Finance (IIF).14,15 The IIF, with a view to moving the process forward, has continued to develop draft Principles-rather than a detailed Code-predicated on enhanced debtor-creditor cooperation that are based on four pillars-information sharing and transparency, close debtor-creditor dialogue and cooperation, good faith actions during debt restructuring, and fair treatment of all parties (Box 1). Based on recent multi-party discussions, there appears to be an increasing consensus within the investor community and among selected emerging market issuers on the draft Principles. While work continues to fine tune the draft and to widen the spectrum of sovereign issuers involved, the IIF expects to circulate the draft Principles to the G-20 in October 2004 for possible endorsement. Notwithstanding the progress on the draft Principles, challenges still remain in devising a tangible Code that is detailed enough to provide practical guidance, while at the same time being sufficiently flexible to be applied to a diverse set of country circumstances. Staff will continue to monitor progress and will provide the Executive Board with a commentary should the Principles be agreed.
IV. Recent Application of the Lending Into Arrears Policy
12. The core objective of Fund financing-to assist effective balance of payments adjustment, without recourse to measures destructive to national and international prosperity and while safeguarding the Fund's resources-underpins the Fund's LIA policy.
13. Under the LIA policy, the Fund lends into sovereign arrears to private creditors on a case-by-case basis and only where (i) prompt Fund support is considered essential for the successful implementation of the member's adjustment program, and (ii) the member is pursuing appropriate policies and is making a good faith effort to reach a collaborative agreement with its creditors.16 In 2002, the Board reviewed the application of the good-faith criterion of the LIA policy and added procedural clarity about the nature and modalities of good-faith efforts expected of debtors during the restructuring process in order to reach a collaborative agreement with creditors.17
14. Financing assurances reviews remain a fundamental requirement of the LIA policy. In particular, after approval of a Fund arrangement involving lending into arrears, financing assurances reviews are required for each purchase until outstanding debt arrears to private creditors have been "cleared" (e.g., through a rescheduling agreement or actual payment). These reviews allow the Board to assess whether developments in creditor-debtor relations have not undermined program implementation and, more specifically, that the member's capacity to repay the Fund has remained intact. The policy applies to all Fund arrangements.18
15. When first formulated in the context of the Brady initiative in 1989, the LIA policy was designed to facilitate the approval of a Fund arrangement before foreign commercial banks had provided assurances regarding their willingness to support a restructuring consistent with the assumptions of the program.19 Since its inception, the policy has evolved with changes in the financial environment of sovereign debtors and their creditors. Most significantly, in 1999, the scope of the policy was broadened to encompass sovereign debt to all private creditors, including holders of international sovereign bonds, recognizing that bonded debt raised particular challenges for restructuring and the provision of Fund financing in that context.20 This section identifies the cases where the LIA policy has been applied in Fund-supported programs over the past two years involving sovereign arrears to private creditors, including in the context of a sovereign debt restructuring.21
Non-HIPC PRGF cases
16. In the context of PRGF arrangements for non-HIPCs, the LIA policy was applied in only two cases.
17. The application of the LIA policy appears to have been less rigorous in the context of PRGF arrangements for HIPC cases.22 The objective of achieving broad participation in the HIPC Initiative has led to programs designed on the assumption that private creditors will provide the full debt relief envisioned in the HIPC Initiative. However, PRGF arrangements for HIPC countries have generally not included explicit financing assurances reviews requiring an assessment that the member was making a good faith effort to reach a collaborative agreement with its private creditors.23
V. Update on The Evian Approach
18. The Evian Approach-a new, flexible, approach adopted by the Paris Club for addressing debt sustainability concerns of non-HIPC countries-is continuing to evolve.25 To date, however, experience with the Evian Approach has been limited.
19. Staff will continue to update the Board on developments in the Evian Approach.
VI. Update on Sovereign Debt Litigation by Private Creditors
20. As recently noted, sovereign debt litigation continues to pose some challenges to the orderly resolution of sovereign debt crises.26 Among the interesting developments in this area are:
Continuing litigation over pari passu clause
21. LNC's appeal to the Belgian Supreme Court (Cour de Cassation) in the LNC v. Nicaragua case attempts to reopen the argument that the pari passu clause provides a creditor with a right to proportionate payment.27 This appeal focuses on the narrow ground of the Brussels Court of Appeal's ruling that, irrespective of the construction of the contractual pari passu clause, such clause could not be invoked against Euroclear, the settlement agent under the Nicaragua's indemnity bonds, since Euroclear was not a party to the contract in which the pari passu clause arose. LNC argues that this conclusion was erroneous as a matter of Belgian law. Consequently, LNC seeks to preserve the ruling in the Elliott/Peru case that accorded the judgment creditor with the right to interrupt payments made in apparent violation of the pari passu clause. The Belgian Supreme Court is expected to rule on LNC's appeal within the next year.
22. The revival of the LNC vs. Nicaragua case indicates that the legal effect of the pari passu clause has not yet been definitively settled in the Belgian courts (nor New York courts).28 Meanwhile, the legislative process is continuing in Belgium to adopt a law that would prevent a judgment creditor from obtaining a court order that would preclude Euroclear from channeling payments from a sovereign debtor to its bondholders. The draft law has already been approved in the legislative Chamber and is now in the final process of formal adoption.
23. The lull in enforcement activity by judgment creditors against Argentina is notable. Judgment creditors may feel somewhat frustrated by the inability to find assets available for attachment. In the New York proceedings, the extensive time spent contesting the scope of information that Argentina should provide on the location of its commercial assets, yielded rather limited information to the judgment creditors. However, it remains to be seen whether the judgment creditors will re-embark on aggressive enforcement proceedings.
24. Notwithstanding the apparent difficulty in enforcing court judgments against Argentina, five additional class actions have been filed in New York court since February, 2004, bringing the pending class actions to fifteen. Only one class action has been certified to date (a procedural step necessary for continuation of the actions) and that action appears to have been stalled by the ruling that bondholders would need to affirmatively opt-in the litigation in order to recover in the class action.
25. However, one of the recently filed class actions, the so-called "Lavaggi class action", raises some novel legal issues.29 In addition to the standard breach of contract claim for non-payment of principal and interest on the bonds, the class action seeks redress for (i) breach of duty of good faith and fair dealing and (ii) unjust enrichment (alleged on the basis that Argentina used the funds available in payment under the bonds "for its own purposes"). Based upon these allegations, the class action seeks punitive damages in excess of US$100 billion from Argentina. A claim for punitive damages in relation to a sovereign debt default is novel and is yet another example of aggressive strategies intended to raise the stakes in sovereign debt litigation.
26. The trend toward the use of CACs in international sovereign bonds issued under New York law has gained momentum. Market acceptance of CACs has continued, with sovereign issues containing CACs growing to represent more than 90 percent of total value of bonds issued. Staff continues to maintain an active dialogue with private market participants and debt managers from a number of emerging market countries to promote the use of CACs. Building on work undertaken in the spring, efforts to develop a Code are continuing in both the G-20 and the Institute of International Finance (IIF). While challenges remain in devising a detailed and tangible Code, the draft general Principles formulated by the IIF could form a basis for further discussions in the G-20 and the wider investor community, and a broad agreement on the Principles could be reached later in the year. As requested by the IMFC, the implementation of the Fund's lending into arrears policy will continue to be reviewed. The Evian Approach-a new, flexible, approach adopted by the Paris Club for addressing debt sustainability concerns in non-HIPC countries-continues to evolve, but experience, to date, with the approach has been limited.
1Communiqué of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund, Washington, April 24, 2004 http://www.imf.org/external/np/cm/2004/042404.htm.
2In this paper, the term "collective action clauses" (CACs) is used to refer to clauses that include both majority restructuring and majority enforcement provisions. The term "international sovereign bonds" comprise bonds issued or guaranteed by the government or central bank that are governed by a foreign law or subject to the jurisdiction of a foreign court.
3The Lebanon bonds include only majority restructuring provisions.
4Israel did not include CACs in its April 2004 bond issued under New York law which is fully guaranteed by the United States with respect to principal and interest. Hong Kong SAR, which issued its first international bond under New York law, did not include majority restructuring provisions, but it did include majority enforcement provisions.
5See Progress Report on Crisis Resolution (SM/04/108, 3/31/04).
6Review of the G-10 Working Group on Contractual Clauses, 9/26/02, www.bis.org/publ/gten08.htm. In particular, Directors expressed the view that it would be reasonable to set the voting threshold at 75 percent of outstanding principal with respect to majority restructuring provisions contained in New York law bonds. Directors generally considered as reasonable the thresholds for majority enforcement provisions that have already been generally accepted in New York law bonds, namely a vote of 25 percent of outstanding principal to accelerate the claims following a default and a vote of more than 50 percent and up to 66⅔ percent of outstanding principal to rescind an acceleration of these claims. See Acting Chair's Summing Up: Collective Action Clauses - Recent Developments and Issues (BUFF/03/52, 4/10/03).
7See Collective Action Clauses - Recent Developments and Issues (SM/03/102, 03/25/03) for a detailed comparison of the design of CACs recommended by the G-10 Working Group and those contained in certain recent New York law bonds.
8While the voting threshold in the Lebanon bond is calculated on the basis of the claims of bondholders present at a duly convened meeting, the threshold in other bond issues is based on the outstanding principal of the bond.
9The Lebanon bond allows individual bondholders to accelerate their claims upon default.
10See Collective Action Clauses - Recent Developments and Issues (SM/03/102, 03/25/03) for a detailed discussion of the differences between a fiscal agency structure and a trust structure.
11 See Box 1 in The Restructuring of Sovereign Debt-Assessing the Benefits, Risks and Feasibility of Aggregating Claims (SM/03/308, 9/4/03) for a detailed discussion of the aggregation feature in Uruguay's bond issue. Uruguay included the aggregation clause in its June 2003, October 2003 and March 2004 bond issues.
12Republic of Latvia Offering Circular dated April 1, 2004 for €400,000,000 4.25 percent Notes due 2014.
13The meeting was held on July 22 in London.
14The IIF's views are presented in an April 2004 press release IIF Calls for Debtor-Creditor Principles for Emerging Markets' Crisis Management and Debt Restructuring, available on its website: http://www.iif.com/.
15Earlier efforts to develop a Code are described in Progress Report to the International Monetary and Financial Committee on Crisis Resolution (IMFC/Doc/9/04/7, 4/21/2004).
16 The LIA policy applies similarly with respect to non-sovereign arrears stemming from the imposition of exchange controls, as outlined in Summing Up by the Acting Chairman on Fund Policy on Arrears to Private Creditors-Further Considerations (BUFF/99/71, 6/18/99).
17 Fund Policy on Lending into Arrears to Private Creditors-Further Consideration of the Good Faith Criterion (SM/02/248, 7/31/02) and The Acting Chair's Summing Up on Fund Policy on Lending into Arrears to Private Creditors-Further Consideration of the Good Faith Criterion (BUFF/02/142, 9/9/02).
18The 2002 Conditionality Guidelines (SM/02/276 Rev. 1, 9/23/02) effectively clarified that the requirement for financing assurances reviews where there were external payments arrears was not limited to Fund purchases (i.e., under the GRA), but includes Fund disbursements (i.e., under the PRGF) as well.
19See Financing Assurances in Fund-Supported Programs (EBS/87/266), The Fund's Policy on Financing Assurances (EBS/89/79), and EBM/89/61; Concluding Remarks by the Chairman on Fund Policy on Sovereign Arrears to Private Creditors (BUFF/98/25) and Fund Policy on Sovereign Arrears to Private Creditors (SM/98/8). Prior to the 1989 modification, arrears to private creditors were encompassed by the Fund's policy on non-toleration of arrears, wherein Fund-supported programs required the elimination of existing arrears and the non-accumulation of arrears during the program period. During the 1980s debt crisis, the policy of non-toleration of arrears was applied with the convention that the acceptance of a term sheet by banks holding a critical mass of principal was treated, for program purposes, as eliminating arrears and providing adequate assurances regarding commercial bank financing.
20See Summing Up by the Acting Chairman on Fund Policy on Arrears to Private Creditors-Further Considerations (BUFF/99/71) and Fund Policy on Arrears to Private Creditors-Further Considerations (EBS/99/64).
21As Bolivia and Uruguay did not accumulate arrears to private creditors, the LIA policy was not applied for these Fund arrangements.
22In some of these cases, representation by the member that the underlying private creditors claims were in dispute resulted in the Fund treating the putative arrears as outside of the purview of the program, consistent with the Fund's general policy on disputed claims; see The Role of the Fund in Settlement of Disputes Between Members Relating to External Financial Obligations (SM/84/89, 4/25/84).
23These and other related issues relating to the role of private creditors in the HIPC cases have been discussed in current and past HIPC progress reports, which have kept the Board apprised of developments (see SM/04/300, 8/2304; EBS/04/96, 7/8/04).
24This decision was reversed on appeal and the litigation is ongoing (see paragraphs 20 and 21, below).
25The Evian Approach is described in Progress Report to the International Monetary and Financial Committee on Crisis Resolution (IMFC/Doc/9/04/7, 4/21/2004). Additional information on the Evian Approach is available on the Paris Club's website: www.clubdeparis.org/en/index.php.
26These issues are discussed at length in Recent Developments in Sovereign Debt Litigation and Implications for Debt Restructuring and Debt Relief Processes (SM/04/98, 3/24/04).
27The case is discussed in paragraph 37 and Annex IV of the Board paper referenced in footnote 21 above.
28Similarly, the ruling in January 2004 of the New York federal court in the litigation between EML and Argentina that a decision on the legal effect of the pari passu clause was not ripe for determination, leaves this legal debate open.
29The proposed class is broad, attempting to cover all bondholders with bonds issued by Argentina since December 23, 2001 "who have been injured by Argentina's default," but excluding plaintiffs in other cases involving bond defaults by Argentina.