Joint meeting of the Institute of International Finance, EMTA and ICMA
Market Acceptance of ICMA’s New Sovereign Debt Contract Reforms
February 5, 2015, London
Creditor Engagement Clauses - Pro's and Con's
March 2, 2015, New York
Joint IIF, ICMA and EMTA Meetings in London and NYC Discuss Pro’s and Con’s of Engagement Clauses
In response to ICMA’s New Sovereign Debt Contract Reforms, joint roundtable meetings of the Institute of International Finance (IIF), the International Capital Market Association (ICMA) and EMTA were held on February 5 at Clifford Chance’s offices in London and on March 2, 2015 at EMTA’s offices in NYC.
The ICMA sovereign debt contract reforms, including model aggregated collective action, pari passu and creditor engagement clauses for inclusion in new sovereign bond contracts, were released in August 2014. They were endorsed by the IIF, and welcomed by many authorities and commentators as a means of facilitating collective action and avoiding restructuring disruptions. Although a number of sovereign borrowers have adopted the new provisions, some aspects relating to creditor engagement have met with resistance and/or indifference.
At these joint IIF, ICMA and EMTA meetings, buy-side market participants, along with leading capital markets and legal professionals, have examined the pro’s and con’s of including creditor engagement provisions in EM sovereign bond contracts.
The March 2 panel, moderated by Hans Humes (Greylock Capital Management), included Charles Blitzer (Blitzer Consulting), Lee Buchheit (Cleary, Gottlieb, Steen & Hamilton), Hung Tran (IIF) and Aaron Kim (PIMCO).
A further EMTA panel on April 13 will endeavor to summarize these proposals and the private sector’s trading and investment community’s reactions to them, and then articulate a sensible path forward. A Washington, DC panel on April 19 is also being organized by IIF to coincide with the upcoming joint IMF/World Bank meetings in April.
EMTA has hosted similar events on the international financial architecture of EM sovereign debt restructurings in NYC, London and Washington, DC in 2013 and 2014.
March 2 Panel Summary
Michael Chamberlin, EMTA’s Executive Director, in his opening remarks clarified that, because of EMTA’s diverse constituency, EMTA’s role was not to come out either for or against the engagement clause per se, but rather to provide a forum where the pro’s and con’s of these type of clauses were understood, vetted and thoroughly discussed. Generally speaking, in times of trouble, creditors are likely to gather, work through their differences with one another and the issuer and find a common path forward. That is as it should be, regardless of whether it is required contractually. The real questions are: Does a contractually mandated engagement clause bring value to the marketplace? If so, how should such a clause be worded? How can inclusion of a generally acceptable engagement clause be encouraged?
Aaron Kim (PIMCO) stated that typically the threshold was 10% for bondholders to request a meeting and that the engagement clause seemed to have been “laser-like removed” from indentures that adopted revised pari passu and CAC clauses that ICMA recommended. He also noted that the ICMA-recommended single limb CAC clause was modified in the recent Mexico indenture to delete the notion that the same terms would apply across all series of bonds, thus enabling the issuer to adopt whatever exchange rate it desired and/or, as Charles Blitzer (Blitzer Consulting) noted, collude against some creditors. If Chile and Panama were to follow Mexico’s example, that would, in Blitzer’s estimation, gut the checks and balances embedded in the ICMA clauses. Lee Buchheit (Cleary, Gottlieb, Steen & Hamilton) responded that it’s likely that there’s nothing sinister about the Mexico documents, and that exclusion of “same terms” language was probably unintentional and likely to be fixed.
Buchheit provided some background on the formation of committees from the Corporation of Foreign Bondholders of the late 1900’s to the 1933 Foreign Bondholders Protective Council to the 1980’s Bank Advisory Committees (BAC’s) and Bank Steering Committees, where the 10-12 banks with the largest credit exposure provided a communications link with issuers, didn’t admit any fiduciary duty to other note/bondholders and negotiated approximately 24 issuers’ debt agreements. The committees’ “fatal flaw” was that all terms be unanimously agreed. While this didn’t matter in the early days when like-minded creditors were part of the committee and moral suasion was used because of peer or regulatory pressure, the need for unanimity was impracticable given the differences in size and geography of the diverse creditors.
Buchheit noted that, as time progressed, the banks became even more disparate in interests and two practices grew: either a committee would be formed to discuss terms with the issuer or the issuer’s financial advisors would consult with market participants to assess the market’s expectations. He claimed that issuers didn’t want a big holdout problem (especially in a CAC environment), and that in recent years issuers were consulting with creditor committees more regularly. Such committees were useful and their principal virtue from the issuers’ standpoint is the “good housekeeping seal of approval” of creditors who have vetted and stress-tested the restructuring proposals. Once engaged with a committee, however, it is difficult for the issuer to disengage even if the process bogs down. An issuer with a diverse debt stock (bonds, loans, trade credits, etc.) cannot in practice attempt to negotiate with each group. And, finally, with more investors mark-to-marking their positions, their instinct is not to form committees too early in the process, but their community of interests dictates a resolution and return of value. Hans Humes (Greylock Capital Management) countered that issuers are more likely to be slow to admit a potential problem.
Humes noted that the balance of power was shifting to creditors (due to the Argentine litigation), and that the latest ICMA-recommended pari passu, CAC and engagement clauses were also part of that mix. He stated that creditors could band together, and this worked even in the complicated Argentine restructuring. Creditors need to be heard and should participate in the restructuring process (albeit primary bondholders may not be as attune as they should be to what is covered by the documents they are signing).
Blitzer provided a spreadsheet of 16 recent restructurings, 12 of which used committees successfully (with a 98.5% success rate), where issuers were engaged and worked in good faith to reach a quick resolution (with the notable Argentine exception). Of the remaining 4 issuers, Dominican Republic was still a successful restructuring without a committee and Dominica was very difficult to restructure and had a low participation rate. He stated that the evidence was clear – committees work, are widely recognized, don’t ask for more than appropriate, are a way to overcome collection action problems and are part of the ICMA-recommended clauses, which should be taken as a whole (a “win/win”). They add integrity into the process and build investor confidence.
Hung Tran (IIF) stated that creditors’ rights have been further weakened by omitting the engagement clause, which contributes to orderly, timely and swift restructurings, while preserving value. While some may think engagement clauses are not necessary, Tran posits that clear ground rules understood by all, which provide for a minimum of 25% of creditors to form committees, are required for an orderly process. Issuers and creditors must engage with one another, and not just through financial advisors. Committees are more efficient and should pool resources to engage with issuers and the IMF. Moreover, committees can provide analyses of an issuer, crystallize the private sector view and provide for bondholder protection.
In response to questions regarding the problems for issuers of no-capped fees and fees not determinable in advance, Tran suggested that those items can be worked out. What is imperative is that creditors have input into the restructuring process, and issuers should not have veto power over the formation of committees. The market for sovereign claims is unenforceable, and the nuisance value of litigation seems to be creditors’ only leverage. With CACs shrinking the power of creditors, a needed balancing tool, such as engagement clauses, is warranted. Why there is such resistance to regular consultation with creditor committees and inclusion of these clauses is troubling.
Buchheit agreed that committees may be useful, but not always, and cited the 2005-6 Iraq restructuring (the largest before Greece), which had a very diverse group of creditors. Multiple committees were formed, each wanting preferential treatment. Times have changed, so winning at least 75% acceptance is essential, and issuers will engage with committees if it makes sense to do so. Blitzer countered that typical minimum thresholds have been below 75%, and that typical participation is 98% with committees and 80% without committees. Humes suggested that Argentina could have had 95% participation and should have tweaked the GDP warrants, but instead chose not to listen to its creditors.
Blitzer responded that Iraq was totally irrelevant, there were indeed no competing, fractious committees, and that a presumptive engagement clause in the documents was a sign of good faith by issuers. Also, a committee can be formed even before a default (i.e., Uruguay). The suggested clause states that a committee be formed if the issuer announces its intent to restructure its debt. Having one “super-aggregated” committee will aid issuers in not having to contend with multiple factions. Committees would provide fair and sensible restructuring terms to preserve creditors’ value.
Tim DeSieno (Morgan, Lewis & Bockius) from the audience suggested that the worry was not so much about issuers, but rather the official sector who may not want to deal with another body, such as creditors’ committees, ex-ante. Buchheit pointed out that the IMF’s lending in arrears program was available only to those sovereigns that acted in good faith negotiations with its creditors, so the protection already exists without the need for actual committees to be hard-coded into the documents. There have been successful restructurings without committees because issuers are under the same pressures.
Chamberlin questioned the expectations for engagement and whether the ICMA clauses are having any effect on pricing of deals. Tran responded that the 2004 Guiding Principles for Fair Capital Flows provided an expectation that issuers act promptly and on a timely basis to get private sector input. The 2006 Principles Addendum reinforced this notion by developing steps to engage a creditor’s committee. He noted that Clifford Chance found that, with 48 recent sovereign bond issuances under NY and UK law, 42% of them had engagement clauses.
Humes noted that more people were starting to pay more attention and financial advisors who just want to get a deal done and collect their fees was not the solution; the most obvious solution to the problem of stripped creditors’ rights was the formation of creditors’ committees. Blitzer stated that, with the possibility of gaming the system and the complexity of negotiations, standardization of an engagement clause (and possibly other clauses as well) was the better approach.