Banks look to strengthen hand in sovereign restructurings

(This article first appeared on the International Financing Review's www.ifre.com, a Thomson Reuters publication)

By Philip Scipio

LONDON, Oct 25 (IFR) - The world's biggest banks are drawing up tactics to strengthen their hand in future sovereign debt restructurings, as they seek to avoid another situation similar to the Greek debt talks, when government pushed them into accepting to tens of billions of euros in writedowns.

The Institute of International Finance, which represents 450 banks around the world that collectively represent the biggest buyers of government debt, has proposed changing the documentation of future bond sales after finding many aspects of the Greek restructuring flawed.

It called for the restoration of the "Principles for Stable Capital Flows and Fair Debt Restructuring" established by the IIF following sovereign debt crises in Latin America, Eastern Europe and Asia. Moreover, it argued that the absence of open dialogue, transparent and good-faith negotiations, plus fair treatment of all investors, endangers the normalisation of market access and financial stability.

The most practical measure the IIF proposes is adding aggregation clauses to documents, which would prevent minority investors - such as hedge funds - from blocking future agreements.

"Fair treatment of all creditors is in the interest of both issuers and creditors," the IIF said in a report. "It lessens the burden on all creditors and, by avoiding discrimination, encourages creditors to participate voluntarily in debt resolution."

The report, written by the IIF's Joint Committee on Strengthening the Framework for Sovereign Debt Crisis Prevention and Resolution, examined the Greek debt restructuring from the vantage point of private creditors.

In particular, the report criticised the retroactive adoption of legislation that introduced a collective action mechanisms into Greek-law government bonds. The manoeuvre raised concerns about the sanctity of financial contracts, the report said.

"The retroactive change in the legal framework governing sovereign debt instruments is worrisome and sets a bad precedent," the report said.

The group argues that appropriately designed aggregation clauses would allow bondholders across classes of government securities to collectively decide on whether to accept potential offers from issuers to modify existing bond terms and conditions.

The use of CACs with aggregation clauses can facilitate voluntary restructuring by reducing the chances of a small minority of bondholders acquiring blocking positions in a bond series and imposing demands for preferential treatment.

GOOD FAITH

The group also demanded that sovereigns make a good-faith effort to negotiate with private creditors at an early stage, including providing enhanced data and policy transparency.

During the Greek PSI negotiations, private investors often felt like they were left in the dark, which limited an open, informed and productive dialogue between private creditors and the Greek authorities, the report said.

It warned that the exclusion of bonds held by official EU institutions from the debt exchange, which resulted in the subordination of private sector investors could have had long-lasting effects on eurozone sovereign debt.

Further, the Troika (consisting of the International Monetary Fund, the European Central Bank and the European Commission) treated the contributions of private creditors as a residual to fill identified financing gaps.

If private creditors are expected to give up their legal rights and accept large financial losses, they need to have an understanding of the changing economic circumstances and of the adequacy of the sovereign debtor's own reform efforts to address the adjustment needs of its economy, the report said.

The group also suggested that mature country issuers adopt investor-relations best practices. Unlike emerging market issuers, the dialogue and cooperation between mature country issuers and their private creditors has been minimal in some cases. (Reporting by Philip Scipio; editing by Gareth Gore, Alex Chambers)