Does governing law affect bond spreads?

Dilip Ratha,Supriyo De,Sergio Kurlat

doi:10.1016/j.ememar.2018.04.005

Abstract

Controlling for bond and issuer characteristics, bond spreads are expected to be equal across different legal jurisdictions, and differences are expected to disappear through arbitrage. However, an analysis of 490 U.S. dollar–denominated bonds issued by 53 emerging market sovereigns during 1990–2015 reveals that after the financial crisis of 2008, launch spreads of sovereign bonds issued under U.K. law have been higher than those issued under U.S. law, by 130 basis points for BB+ bonds and 175 basis points for B− bonds. This effect was not significant for investment grade bonds. On average, bonds issued under U.K. law had weaker ratings and shorter tenors post-crisis. The post-crisis impact of governing law on sovereign bond spreads is not explained by collective action clauses, or first-time bond issuances. Instead, the difference seems to be related to the perception that U.S. law offers stronger investor protection, and that the investor base for bonds issued under U.S. law is larger than that for bonds issued under U.K. law. The difference in spreads persists in the secondary market even after 180 days, perhaps because of the lack of liquidity, as investors tend to buy and hold these more attractive bonds on a longer-term basis.

Highlights

This paper explores whether the governing law has any lasting impact on sovereign bond spreads
Bonds issued under U.K. law had weaker ratings and shorter tenors post-crisis (Figures 6 and 7)
This paper explored the phenomenon of higher launch spreads of dollar-denominated sovereign bonds issued under U.K. governing law when compared to those under U.S governing law

Summary

Introduction

This paper explores whether the governing law has any lasting impact on sovereign bond spreads. The re-emergence of the U.K. as a major financial center commenced with the rapid deregulation of U.K. financial markets and changes in the London Stock Exchange carried out during the tenure of Margaret Thatcher in 1986.5 it was only in the post-crisis period that the volume of dollar-denominated central government debt issued under U.K. law came close to and at times surpassed that of U.S law issues (Figure 3). This transition coincided, in part, with major regulatory changes brought about in the United States after the crisis, while Britain continued with its “light touch” regulatory approach. How far controlling for these differences would explain the observed spread difference is something we would empirically explore

20 Number of years

This practice had some historical foundation

Explaining the difference in launch spreads

Findings

Conclusions and policy considerations