By Ezra Fieser and Zijia Song
A shakeup is brewing in the $1.6 trillion universe of emerging-market sovereign debt — whether Wall Street likes it or not.
As government defaults rise to a record in the developing world, the debate is growing frantic over how to solve these debt crises. Restructuring talks are stalling, with some countries turning to old-school sweeteners and others calling to revamp the Group of 20’s Common Framework.
In New York, a cohort of debt-relief activists and US state politicians are pushing for a more-permanent solution: a law that would overhaul the process of restructuring sovereign debt.
“There’s a lot of focus post-Covid on debt and development issues,” said Deborah Zandstra, a partner at law firm Clifford Chance, which advises some investors. “There’s a lot of ongoing campaigning from civil-society organizations, and so on, as to how to improve the kind of ad hoc architecture we’ve had for debt restructurings.”
Hence the momentum behind a pair of bills winding their way through committees in New York, a state with laws that govern roughly half of foreign bonds issued by emerging-market sovereigns.
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The proposals would limit how much investors are allowed to recoup when countries restructure their debts — a concept that’s riling up Wall Street.
Even so, almost everyone agrees that the need for some kind of overhaul is mounting. There are 11 emerging nations with dollar debt trading at a risk premium of at least 10 percentage points — a distressed level that signals the threat of default.
Lebanon, Sri Lanka, Zambia and others have already tumbled into default, locking the economies out of international capital markets until a deal can be struck with creditors.
Fixing the System
The bills in New York are far from the only efforts to address this modern sovereign-debt dilemma, though other initiatives have largely fallen short.
No country has successfully used the Group of 20’s so-called Common Framework, a plan launched in late 2020 to help borrowers restructure debts with many creditors under the same terms.
Investors, meanwhile, are raising eyebrows with a push to incorporate high-fangled sweeteners into deals that grant them access to a country’s future cash pile. While Suriname was able to strike a restructuring deal using an oil-linked security, the tools come with a problematic past in countries such as Argentina.
That explains the focus on the bills in New York, which have gotten further than previous attempts to alter the process via state law. Still, the timing will be tight as the senate and assembly break for summer on June 8.
Advocates, ranging from economist Joseph Stiglitz and Argentina’s former economy minister Martin Guzman to charities like Jubilee USA Network, say the new rules would help sovereign debtors move on from default faster, cut down negotiating costs and save US taxpayer money.
Major asset managers on Wall Street take another view. Investor trade groups have warned that the bills would only make it harder and costlier for poor countries to access capital markets.
“You’ll see the market for these bonds shrink,” said David Knutson, a senior investment director at Schroder Investment Management and chair of the Credit Roundtable, a group representing bondholders. “If you’re a lower-rated sovereign and there’s a limit put on the recovery when things go sideways, you’re going to see a meaningful increase” in borrowing costs.
Clifford Chance lawyer Zandstra also pointed out that stalled negotiations are often caused by public creditors rather than bondholders.
“The primary ripple to restructuring now is you have failure to reach agreement among official creditors,” said Mark Weidemaier, a law professor at the University of North Carolina who’s studied contracts and sovereign debt. “That’s the primary source of delay.”
Tension is high with less than two weeks left for New York state lawmakers to vote on the bills. Politicians in the UK are watching closely as pressure mounts to ensure greater sovereign-debt relief for poor nations. After New York, London laws are the most relevant for global emerging government debt.
Legislation that prevents creditors from holding up restructuring deals “is the theme that has preoccupied the sovereign-debt community since the Argentine bond default in 2001,” said Lee Buchheit, a lawyer with more than four decades of sovereign debt-restructuring experience.
After that infamous $95 billion default, most bondholders agreed to accept deep losses on their holdings in order to restructure. But a contingent led by hedge-fund billionaire Paul Singer held out for years and demanded full repayment.
A country’s creditors still have “no good machinery in place to coordinate their responses to a debt crisis,” Buchheit said.