Sovereign debt needs strong collective action clauses – ECB paper

CACs with bond-by-bond voting fail to prevent creditor holdouts, researchers find

Only the strongest form of collective action clause (CAC), in sovereign debt is likely to achieve its aims, a European Central Bank paper finds.

In Restructuring sovereign bonds: holdouts, haircuts and the effectiveness of CACs, Chuck Fang, Julian Schumacher and Christoph Trebesch study the “holdout problem”, when creditors refuse to participate in a sovereign debt restructuring.

The authors use data on 23 episodes of sovereign bond restructurings involving foreign creditors since 1994. This data shows holdouts varying “from 0–100%, with a standard deviation of 24.7 percentage points”, they find.

In an effort to prevent holdouts, issuers of sovereign debt have begun imposing CACs on bond buyers. The authors find the presence of CACs is “not a good predictor for initial holdout rates”.

In order to explore how well CACs work, the authors conduct a simulation exercise for three of the largest recent restructuring deals – in Argentina, Uruguay and Greece. They try to gauge how three different types of CAC would have affected any bond deal.

So-called “classic CACs”, which have a bond-by-bond voting process and a voting threshold of 75% of bonds held, would not have prevented holdouts, the authors find. Neither would “Euro-CACs”, also called “two-limb” CACs, which require a bond-by-bond vote and a voting threshold of 50%.

The only kind of CAC that would have effectively minimised the chances of holdouts in the sample cases were “single-limb CACs”. These are the strongest form of CACs, requiring a single vote across all bonds. The International Capital Market Association recommends these CACs have a voting threshold of 75%, while the bonds issued in the eurozone since 2013 have a voting threshold of 66.6%.

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