Sovereign Bond Contracts Research Articles

Innovation Versus Encrustation: Agency Costs in Contract Reproduction

This article studies the impact of exogenous legal change on whether and how lawyers across four different deal types revise their contracts’ governing law clauses in order to solve the problem that the legal change created. The governing law clause is present in practically every contract across a wide range of industries and, in particular, it appears in deals as disparate as private equity M&A transactions and sovereign bond issuances. Properly drafted, the clause increases the ex ante economic value of the contract to both parties by reducing uncertainty and litigation risk. We posit that different levels of agency costs are the motivating factors that influence beneficial innovations in governing law clauses as well as their mirror opposite, costly encrustations. Our data show that lawyers who draft private equity M&A deals pay more attention to the deal terms than lawyers producing corporate and sovereign bond contracts. Because agency costs are low in the private equity setting, we observe significantly more innovation in private equity deals as compared to sovereign and corporate bond transactions where the agency problems of drafting lawyers are much greater. More surprising, we also find that contracts drafted by private equity M&A lawyers have more obsolete and encrusted terms than the contracts of the other deal types. Our conjecture is that the lawyers' dominant drafting strategy is to find examples of a desired term in other documents and import that language verbatim into the contract together with other redundant and obsolete terms including, on occasion, terms that may harm the clients' interests if retained in the contract.

If Boilerplate Could Talk: The Work of Standard Terms in Sovereign Bond Contracts

Standard contract terms are “sticky”: they rarely change, even if change appears to be in the parties’ interest. Multiple theories to explain stickiness do not reach consensus on its causes. We investigate the role of stickiness in sovereign bond contracts, where it would be especially costly and therefore puzzling. In our interviews with more than a 100 officials responsible for the bond contracts of twenty-eight countries, they linked reluctance to change non-financial contract terms and the imperative of following a “market standard” for such terms. When a term could be described as standard for the government’s debt stock or borrower cohort, its content often came across as secondary. Sovereign debt managers seemed willing to forgo some of the benefits of contract terms for dealing with contingencies and revealing private information to avoid negative signals and maintain the liquidity of primary and secondary debt markets. Interviews with investors suggested a similar focus on standard form and a limited engagement with contract substance.

How Good Is the Public Data on Sovereign Bond Contracts?

Commercial databases now make available to paying clients information about the legal terms in sovereign loan contracts. This information is important to academic researchers, to policy institutions such as the International Monetary Fund, and to investors and other market actors. For a random sample of ten countries, we compare this data to a hand-coded sample of bond terms. We find significant error rates in the commercial databases, which vary by country and by the legal term at issue. In some cases, we document error rates well over 75 percent. We also describe important limitations in the data, especially the use of binary coding schemes that obscure important differences in the rights conferred by different sovereign loan contracts.

Sovereign Bond Contracts: Flaws in the Public Data?

Abstract Commercial databases now make available to paying clients information about the legal terms in sovereign loan contracts. This information is important to academic researchers, to policy institutions such as the International Monetary Fund, and to investors and other market actors. For a random sample of 10 countries, the authors compare this data to a hand-coded sample of bond terms. They find significant error rates in the commercial databases, which vary significantly by country and by the legal term at issue. In some cases, they document error rates well over 75 per cent. They also describe important limitations in the data, especially the use of binary coding schemes that obscure important differences in the rights conferred by different sovereign loan contracts.

Can Human Development Bonds Reduce the Agency Costs of the Resource Curse?

Abstract Especially in resource rich countries with weak institutions of governance, the interests of governments often diverge from those of their citizens and creditors. Sovereign bond contracts can potentially help align these interests, to the benefit of all parties, by indexing payment obligations to improvements in the health and education of the issuer’s citizenry. To that end, this Article proposes a Human Development Bond (HDB) with a variable coupon schedule that both insures issuers against recessions and incentivizes them to encourage investment in human capital when economic growth is strong. The potential benefits of such an instrument can only be realized, however, with significant support from the international community. Moreover, further empirical research is needed to calibrate the HDB’s coupon schedule to provide well-timed and appropriately sized debt relief.

Third Progress Report on Inclusion of Enhanced Contractual Provisions in International Sovereign Bond Contracts

The IMF Executive Board endorsed in October 2014 the inclusion of key features of enhanced pari passu provisions and collective action clauses (CACs) in new international sovereign bonds.1 Specifically, the Executive Board endorsed the use of (i) a modified pari passu provision that explicitly excludes the obligation to effect ratable payments, and (ii) an enhanced CAC with a menu of voting procedures, including a “single-limb” aggregated voting procedure that enables bonds to be restructured on the basis of a single vote across all affected instruments, a two-limb aggregated voting procedure, and a series-by-series voting procedure.2 Directors supported an active role for the IMF in promoting the inclusion of these clauses in international sovereign bonds.3 The IMFC and the G20 further called on the IMF to promote the use of such clauses and report on their inclusion. Since that time, the IMF has published periodic progress reports on inclusion of the enhanced clauses.4 These reports found that since the Executive Board’s endorsement, substantial progress had been made in incorporating the enhanced clauses, with approximately 85 percent of new international sovereign bond issuances since October 2014 (in nominal principal amount) including such clauses. The reports also found that there was no observable market impact on inclusion of the enhanced clauses. However, the reports noted that the outstanding stock without the enhanced clauses remained significant, with issuers showing little appetite for liability management exercises to accelerate the turnover. This paper provides a further update on the inclusion of the enhanced clauses and on the outstanding stock of international sovereign bonds as of September 30, 2017. Section II reports on the inclusion of these enhanced provisions, finding that the vast majority of issuers are including these clauses, with only a few countries standing out against the market trend. Section II also provides an update on the outstanding stock, indicating that while the percentage of the outstanding stock with the enhanced clauses is increasing, a significant percentage of the stock still does not and little action has been taken by issuers to increase the rate of turnover. Section III briefly reports on the use of different bond structures, and Section IV describes the staff’s ongoing outreach efforts and next steps.

If Boilerplate Could Talk

Standard contract terms are “sticky”: they rarely change, even if change appears to be in the parties’ interest. Multiple theories to explain stickiness do not reach consensus on its causes. We investigate the role of stickiness in sovereign bond contracts, where it would be especially costly and therefore puzzling. In our interviews with more than a hundred officials responsible for the bond contracts of 28 countries, they linked reluctance to change non-financial contract terms and the imperative of following a “market standard” for such terms. When a term could be described as standard for the government’s debt stock or borrower cohort, its content often came across as secondary. Sovereign debt managers seemed willing to forgo some of the benefits of contract terms for dealing with contingencies and revealing private information, to avoid negative signals and maintain the liquidity of primary and secondary debt markets. Interviews with investors suggested a similar focus on standard form, and a limited engagement with contract content.

Courts and sovereigns in thepari passugoldmines

The pari passu clause in sovereign bond contracts has spawned an improbably huge academic literature and a fast-growing jurisprudence, culminating in recent U.S. federal court decisions, which used the clause to block payments on nearly $30 billion in Argentinian debt. The academic literature, judicial opinions, briefs and expert reports going back to the mid-1990s all assume that no court had interpreted the pari passu clause in sovereign debt before the year 2000. It turns out that there were at least four instances of such interpretation in the twentieth century.This essay discusses litigation in Switzerland in the 1930s and a decade-long international arbitration in the 1970s, in which four different panels considered the meaning of pari passu clauses in German Young Loan bonds. All four panels interpreted the clause in ways that might well be consistent with those of the U.S. federal courts; however, the bondholders still lost.Documents from the League of Nations archives suggest that the 1930s lawsuit against the Bank for International Settlements as trustee for the German bonds influenced proposals for contract and institutional change in sovereign debt management, notably with respect to the role of the bond trustee. To the extent such reforms might have had a chance, World War II and its aftermath put them on hold until the turn of the 21st century. As the dust from Argentina's debt saga begins to settle, the old disputes over the meaning of pari passu offer unexpected lessons for debt enforcement and contract reform.

<i>Pari Passu's</i> Golden Fossils

The pari passu clause in sovereign bond contracts has spawned an improbably huge academic literature and a fast-growing jurisprudence, culminating in recent U.S. federal court decisions, which used the clause to block payments on nearly $30 billion in Argentinian debt. The academic literature, judicial opinions, briefs and expert reports going back to the mid-1990s all assume that no court had interpreted the pari passu clause in sovereign debt before the year 2000. It turns out that there were at least four instances of such interpretation in the twentieth century.This essay discusses litigation in Switzerland in the 1930s and a decade-long international arbitration in the 1970s, in which four different panels considered the meaning of pari passu clauses in German Young Loan bonds. All four panels interpreted the clause in ways that might well be consistent with those of the U.S. federal courts; however, the bondholders still lost.Documents from the League of Nations archives suggest that the 1930s lawsuit against the Bank for International Settlements as trustee for the German bonds influenced proposals for contract and institutional change in sovereign debt management, notably with respect to the role of the bond trustee. To the extent such reforms might have had a chance, World War II and its aftermath put them on hold until the turn of the 21st century. As the dust from Argentina's debt saga begins to settle, the old disputes over the meaning of pari passu offer unexpected lessons for debt enforcement and contract reform.

Cost and Efficacy of Collective Action Clauses

Recent developments in sovereign capital market, such as the debt crises in Eurozone, the massive restructuring by Greece, and the escalated tension between Argentina and its holdout creditors, have brought Collective Action Clauses (CACs) back to limelight. These clauses in sovereign bond contracts are claimed to address the coordination problem among creditors and thus enable a more orderly restructuring process, and previous researches have found little cost of carrying these “insurances” for debtor countries. In this research, I revisit the cost question through a replication method and new evidence made available by the Eurozone CACs mandate, and I examine the actual efficacy of CACs by surveying the 22 sovereign bond restructurings since 1970, on which there has been little empirical analysis as I am aware of. My analysis finds that Euro CACs with the aggregation feature are associated with little but positive addition to borrowing cost, and riskier investments with lower credit rating and longer maturity are subject to higher CACs premium. At the same time, CACs have not significantly affected the outcome of restructurings after controlling for other factors such as creditor structure, haircut, and government coerciveness. This cost-benefit analysis lead me to conclude that although CACs do not lead to substantially higher borrowing cost – even the “Super CACs” with the aggregation feature, including them does not necessarily guarantee a more orderly restructuring, and thus more dramatic reforms may be necessary if further improvement in the restructuring process is desired.

Interpreting the pari passu clause in sovereign bond contracts: it is all Hebrew (and Aramaic) to me

In this comment, we take a helicopter tour of the history of notions of “equality” and “justice” in sovereign debt restructuring in particular, and in the division of property more generally, and show that these concerns have existed for centuries, if not millennia. We argue that the issue at stake in the interpretation of the pari passu clause is not so much the treatment of holders of identical claims– it is now customary to treat them identically– but whether the holders of different claims should be treated differently. We show that exists a customary “principle of differentiation” that allows creditors with claims that differ in specific ways to be treated preferentially. One of these specific differences concerns debts that have been reduced in value during a previous debt restructuring or default, and based on this principle we conclude that the New York court has, if not completely misinterpreted the meaning of the pari passu clause, then at least misapplied it.

Interpreting the Pari Passu Clause in Sovereign Bond Contracts: It's All Hebrew (and Aramaic) to Me

In this comment, we take a helicopter tour of the history of notions of "equality" and "justice" in sovereign debt restructuring in particular, and in the division of property more generally, and show that these concerns have existed for centuries, if not millennia. We argue that the issue at stake in the interpretation of the pari passu clause in sovereign bond contracts is not so much the treatment of holders of identical claims -- it is now customary to treat them identically -- but whether the holders of different claims should be treated differently. We show that exists a customary "principle of differentiation" that allows creditors with claims that differ in specific ways to be treated preferentially. One of these specific differences concerns debts that have been reduced in value during a previous debt restructuring or default, and based on this principle we conclude that the New York court has, if not completely misinterpreted the meaning of the pari passu clause, then at least misapplied it.

Interpreting the <I>Pari Passu</I> Clause in Sovereign Bond Contracts: It's All Hebrew (and Aramaic) to Me

In this comment, we take a helicopter tour of the history of notions of ?equality? and ?justice? in sovereign debt restructuring in particular, and in the division of property more generally, and show that these concerns have existed for centuries, if not millennia. We argue that the issue at stake in the interpretation of the pari passu clause is not so much the treatment of holders of identical claims?it is now customary to treat them identically?but whether the holders of different claims should be treated differently. We show that exists a customary ?principle of differentiation? that allows creditors with claims that differ in specific ways to be treated preferentially. One of these specific differences concerns debts that have been reduced in value during a previous debt restructuring or default, and based on this principle we conclude that the New York court has, if not completely misinterpreted the meaning of the pari passu clause, then at least misapplied it.

Collective Action Clauses in Sovereign Bond Contracts and Investment Treaty Arbitration – An Approach to Reconcile the Irreconcilable

Among various attempts to achieve swift and orderly sovereign debt restructuring (SDR), the approach to include collective action clauses (CACs )i n bond contracts has been widely adopted. CACs are expected to reduce the holdout litigation risk as they allow a specified supermajority of creditors to impose changes to the restructuring terms on holdout creditors. Meanwhile, SDR faces a new chal- lenge in the sphere of the law on foreign investment: recent investment arbitration tribunaldecisionsonSDRopenedthegatetoinvestmenttreatyarbitrationforholdout creditors. Investment arbitration has potential to surpass the contractual restrictions set by CACs and therefore undermine the primary purpose of CACs to reduce the risk ofholdoutlitigation.ThismaycausedelayintheSDRprocess,whichisnotinthebest interest of either the creditors or the debtor state's economic recovery. The protection of foreign investments should be, therefore, balanced against the need for a swift SDR. Against thisbackground,thisarticle argues that a way to achieve the balance is to set limits on the use of investment treaty arbitration by holdout creditors, and defaults and restructurings of international bonds and/or the implementation of CACs should be excluded from the scope of investment treaty arbitration. This is becausewhileliabilitiesunderinvestmenttreatiesarisefromtheexerciseofsovereign power of the host state, such acts do not constitute acts of a sovereign with respect to the bondholders butremainintherealmof commercial transactions. To demonstrate this,thisarticlefirstexaminesthedistinctionbetweenactajuregestionisandactajure imperii, which has been developed in the context of the doctrine of restrictive state immunity, and finds that issuance and default of international sovereign debts have beentreatedascommercialactivitiesbyEnglishandUScourts,thetwomajordispute settlementforumsfordisputesarisingfrominternationalsovereignbonds.Bearingin mindthedifferencebetween(a)thequestionthesecourtsface(i.e.whethertheyhave jurisdiction over contractual claims) and (b) the question before investment treaty arbitration(i.e.whethertherearetreatyclaimstobeprotectedbyinvestmenttreaties), this article then argues that investment arbitration tribunals should reach the same conclusion as to the nature ofthe hoststate's actsconcerning international sovereign

The Three and a Half Minute Transaction: Boilerplate and the Limits of Contract Design

Theory tells us that the lawyers who draft standard-form contracts will respond to an erroneous court interpretation of a boilerplate contract term by revising the standard formulation of the clause or otherwise clarifying the ambiguity. This is so because lawyers, it is assumed, have the incentive to protect clients from the risk that other courts may adopt the disfavored interpretation or that the apparent ambiguity will, in any event, produce future costly litigation. As many scholars have observed, the reality is often different. Boilerplate terms in standard contracts are sticky. Many of the theories explaining why standard contract terms are resistant to innovation focus on the efficiency benefits of market-wide standardization. Others look to economic or psychological factors that deter the production of innovative terms. In this book, we use both qualitative and quantitative data to explore the reasons for the phenomenon of stickiness in sovereign bond contracts. We focus on a novel judicial interpretation of an obscure clause in cross-border financial contracts – the pari passu clause – that rattled the chandeliers of international finance. One might have expected the practicing bar to quickly clarify their forms before the heresy could spread and gain traction. But that didn’t happen. In over 90% of the contracts subsequently issued, no attempt was made to clarify the imprecise language of the clause. None of the extant theories of stickiness explain what we find. Rather, the story that emerges is about the modern big law firm: the financial pressure on big firms to maintain a high volume of transactions contributes to an array of conflicts that that deter innovation and are largely hidden from the individual lawyers charged with drafting responsibility – conflicts that are hidden in part by the myths that the members of this legal community collectively tell themselves about the origins of boilerplate terms whose meaning has been lost in time.

How Markets Work: The Lawyer's Version

In this article, we combine two sources of data to shed light on the nature of transactional legal work. The first consists of stories about contracts that circulate widely among elite transactional lawyers. Surprisingly, the stories portray lawyers as ineffective market actors who are uninterested in designing superior contracts, who follow rather than lead industry standards, and who depend on governments and other outside actors to spur innovation and correct mistakes. We juxtapose these stories against a dataset of sovereign bond contracts produced by these same lawyers. While the stories suggest that lawyers do not compete or design innovative contracts, their contracts suggest the contrary. The contracts, in fact, are entirely consistent with a market narrative in which lawyers engage in substantial innovation despite constraints inherent in sovereign debt legal work. This raises a puzzle: Why would lawyers favor stories that paint them in a negative light and deny them a potent role as market actors? We conclude with some conjectures as to why this might be so.

ISSUES IN FINANCE: CREDIT, CRISES AND POLICIES - AN OVERVIEW

ISSUES IN FINANCE: CREDIT, CRISES AND POLICIES - AN OVERVIEW

Individual Enforcement Rights in International Sovereign Bonds

Sovereign bond contracts are notoriously hard to enforce. The few rights that bondholders have can be vested either collectively or individually. It seems that investors traditionally had a preference for the latter, which hindered financial market reform projects, such as the universal adoption of collective action clauses or trust structures. This paper discusses theoretically and empirically whether it is indeed in the bondholders’ collective interest to be allowed to individually sue and attach the debtor country’s assets following a default. Market reaction to the landmark case of Elliott Associates v. Peru is tested to assess just how much bondholders actually value individual enforcement rights. It is found that even the single most important event to reinforce creditor rights in recent years provoked no systematic movement in bond prices. We thus conclude that perhaps the importance of individual enforcement rights to the markets has been exaggerated and we therefore recommend ignoring any opposition from market participants that may arise during the necessary transition to more collective enforcement rights.

Good Faith in Sovereign Debt Restructuring: The Evolution of an Open Norm in 'Localised' Contexts?

Since the Argentine debt crisis in 2001 (and the settlement of 2005) the influence and credibility of the official sector especially the IMF is at a historical low. It is in this context that changes in sovereign bond contracts, for instance, the widespread adoption of collective action clauses raise questions about future debt restructurings. Market participants, especially creditors overwhelmingly believe that contract modification is important but only ‘at the margins’. If contractual change is marginal, what then are the mechanisms that will ensure fair and orderly debt workouts? In the absence of a global, multilateral, regulatory framework for sovereign debt restructuring, our examination of changes in the period leading up to the Argentine settlement and after, reveals that market participants may instead be relying on good faith to do the job with the court recognising similar expectations. Good faith, though entrenched as a legal norm in several domestic jurisdictions, such as Germany and the U.S., is a relative newcomer to sovereign debt workouts. This evolving norm is not institutionally embedded and unlike the domestically entrenched version, is not a legal rule with specific requirements that needs to be fulfilled. We conclude by showing that good faith is an open norm ‘localised’ inter alia in formal and informal contexts in which market participants interact with each other and therefore conceptually similar to Treu und Glauben as recognised in section 242 BGB.

Sovereign Debt Restructuring: The Judge, the Vultures and Creditor Rights

What role did the US courts play in the Argentine debt swap of 2005? What implications does this have for the future of creditor rights in sovereign bond markets? The Judge in the Argentine case has, it appears, deftly exploited creditor heterogeneity – between ‘holdouts’ seeking capital gains and institutional investors wanting a settlement – to promote a swap with a supermajority of creditors. Our analysis of Argentine debt litigation reveals a ‘Judge‐mediated’ sovereign debt restructuring which resolves key issues of Transition and Aggregation – two of the tasks envisaged for the IMF's stillborn Sovereign Debt Restructuring Mechanism. For the future, we discuss how Judge‐mediated sovereign debt restructuring (together with creditor committees) could complement Collective Action Clauses in sovereign bond contracts.