Restructuring of sovereign debt faces legal hurdles

Argentina may be on the home straight of the marathon legal battle over the restructuring of its debts, but investors need to be wary that there are plenty of other strained countries that litigation-loving funds can swoop on if they want.

With default worries now rising, there are over a hundred billion dollars of, especially older, emerging market bonds that do not have collective action clauses (CACs) which help avoid Argentina-style fights.

CACs typically spell out that any restructuring can go ahead with a 75 per cent approval from investors, binding any dissenting creditors in the process and avoiding lengthy legal battles in courts.

Oil-dependent Venezuela, which is in the grip of a recession due to the commodity rout and has annual inflation of 190 per cent, is seen as at highest risk of a default this year by economists.

Close to $40 billion of its bonds, however, have no CACs, including all of the $35.6 billion issued by state-owned oil company PDVSA, meaning it could be exposed to a lengthy legal grapple with holdouts.

It is by no means alone. Rodrigo Olivares-Caminal, chair in banking and finance law at Queen Mary University in London, says as a rule of thumb any bond issued before 2003 under New York law won’t have a CAC.

The IIF estimates that adds up to around 10 to 15 per cent of the almost one trillion dollars of emerging market sovereign debt outstanding and includes the likes of Brazil, Colombia and Russia, although the latter tended in the past to favour English law terms.

“If you don’t have CACs, you will always have the threat of having holdouts,” OlivaresCaminal said.

“The countries to focus on are the big ones that are in distress at the moment, Venezuela and Brazil. It is not an issue right now but you should also keep in the back of your mind Russia, and don’t forget Africa either.”

An IMF paper from late last year showed that clear lines can’t been drawn either. Of 73 bonds issued since October 2014, roughly 40 per cent didn’t have CACs.

The lack of these clauses could stagger the restructuring process and cause delays that in the case of Argentina led to the country’s 15-year isolation from the capital markets. Good news for the lawyers but few others.

Kevin Daly, on the investment committee at Aberdeen Asset Management, said another country now on the watch list was Mozambique. It has been making noises about restructuring one of its quasi-sovereign bonds and Daly said there are no CACs, meaning the process may not be simple.

Hung Tran, executive managing director at the IIF, said a lack of CACs in focused restructurings can sometimes be more problematic than bigger ones.

“A fact that a bond does haven’t a CAC doesn’t automatically mean it will be messy like Argentina,” he said pointing to Uruguay’s speedy restructuring over a decade ago.

“But without CAC, it can be more difficult if it is for a single issue, as someone can easily build up a big enough stake to block a restructuring.”

It doesn’t only affect sovereigns, plenty of companies are in similar situations. Data from Standard & Poor’s shows corporate default rates are currently running at their highest rate since the fallout of the financial crisis in 2008-09.

South Africa’s Eskom has seen its bonds rattled and Brazil’s floundering state oil producer Petrobras is another on the watch list as the oil slump pressure builds and its rating tumbles.

Petrobras is already eyeing a $22 billion debt-for-equity swap with its bank lenders but there are niggling concerns about its bonds.

15%

of emerging market sovereign debt don’t have collective action clauses