New ICMA sovereign collective action and pari passu clauses 1

Briefing note October 2014

New ICMA sovereign collective action and pari passu clauses ICMA's new model aggregated collective action clauses and pari passu clause for sovereign issuers offer flexibility to sovereigns wishing to restructure their debts while at the same time providing robust protection to noteholders through the procedures and majorities required in order to restructure those debts. The clauses will not solve immediately all the problems in sovereign debt restructuring, but they are a significant step in the right direction. The approach taken by ICMA's new CACs has the support of the IMF.

Whatever the rights and wrongs of the One pragmatic solution that has travails faced by Argentina since it garnered support is enhancing the defaulted on its debts in 2001, no one contractual mechanisms already used Key issues could describe the subsequent in the capital markets. Sovereign process as orderly. Thirteen years on, note issues involve contracts between  ICMA's new CACs offer the fallout continues to occupy the issuers and noteholders. Why not sovereign issuers three courts, both in New York and expand the terms in those contracts restructuring options elsewhere, despite over 90% of that facilitate restructuring, if that is  The most innovative option is Argentina's noteholders having what the issuer wants and the a single vote across multiple agreed to the restructuring of their noteholders agree? series notes. Argentina remains shut out of the international capital markets, and The terms in question - collective  The CACs include protection no permanent solution is in sight. action clauses (or CACs) - allow for minorities against noteholders to vote on a restructuring oppression Argentina is not, however, the norm. or re-profiling proposal, with the  The sovereign must provide Other recent sovereign debt outcome of that vote binding all information to enable informed restructurings (eg the Seychelles, St noteholders. The new development voting Kitts and Nevis, Belize and Greece) in this area is a recognition that voting  ICMA has also issued a have been undertaken without the need not be confined to one particular sovereign pari passu clause same protracted public drama. series of notes but can extend to disavowing payment equality Nevertheless, numerous ideas multiple series of notes (aggregation) (including a "sovereign debt provided that they all contain the restructuring mechanism" - effectively which represents a broad range of necessary contractual provisions. an insolvency regime for sovereign interests in the capital markets, has states) have been floated over the The members of the euro area now published a new model form of years as to how the sovereign debt committed themselves to including CACs with aggregation features that restructuring process might be the area's form of aggregated CAC in can be used by any sovereign issuer. reformed in order to minimise the risk all new government securities issued The publication of these standard of Argentina-like disorder, but most after 1 January 2013 with a maturity form CACs follows two consultations ideas have been weighed down by above one year. The International amongst ICMA's members, as well as the complex politics and Capital Market Association, the extensive discussions with other key (im)practicalities involved. leading trade body in this area and stakeholders, including the Institute

2 New ICMA sovereign collective action and pari passu clauses

for International Finance and a restructuring agreed among sovereign conditions of financial contracts may working group convened by US issuers and their private creditors and undermine the integrity of financial Treasury staff consisting of endorsed by the G20. markets and the sanctity of representatives from the official sector, contracts and should be avoided. including the IMF, legal experts, ICMA's sovereign CACs However, in exceptional cases and market participants, practitioners, ICMA's CACs are standard forms for after a voluntary debt exchange academics and issuers. use in any sovereign note issue. As agreement has been reached, such such, they must be capable of modifications of the governing legal Use of ICMA's CACs is not an applying to a wide range of framework to introduce a collective overnight solution to all the problems circumstances, from a sovereign with action mechanism on a timely basis in sovereign debt restructuring. only a couple of near identical note with terms and thresholds Amongst other matters, it will take issues to a sovereign with hundreds consistent with market practices some years before a critical mass of of issues across different markets and may be necessary in facilitating a any sovereign issuer's notes contains in different currencies. A single voluntary debt exchange and the CACs. But, with the passage of approach to restructuring is unlikely to achieving a fair outcome for all time, the use of ICMA's CACs will be practicable for all situations. bondholders." (Report on assist countries facing financial Implementation of the Principles for difficulties to seek an accommodation As a result, ICMA's CACs offer a Stable Capital Flows and Fair Debt with their noteholders in a sovereign three options to restructure Restructuring, IIF, 2013) constructive manner and will facilitate its debts: debt restructuring, if that is what the In part reflecting the recent work by  Modification of a single series of sovereign and its noteholders want, euro area members on their own form notes while minimising the risks posed by of CAC, which applies to both holdout creditors.  Modification of multiple series of domestic and foreign law issuances, notes, with a requirement that the as well as their ESM Treaty The IMF has very recently published restructuring be approved both by obligations, euro area members are a paper (Strengthening the all noteholders voting together expected to continue to use their own Contractual Framework to Address and by noteholders voting within aggregated CAC. Collective Action Problems in their particular notes (two limb Sovereign Debt Restructuring) voting) Modification of a single recognising that, while it cannot series mandate the use of CACs, it should  Modification of multiple series of play an active role in promoting their notes, with one aggregated vote This is the conventional form of CAC, inclusion in international sovereign amongst all noteholders (single which has been used in sovereign bonds. The IMF concluded that the limb voting) debt issues for over a decade. It design features in ICMA's CACs allows a majority of the holders of any ICMA's CACs are intended primarily address collective action problems particular series of notes to agree for use in foreign law note issues, effectively while affording adequate changes to the terms of their notes in where the restructuring problems are safeguards for noteholders. ICMA's a manner that is binding on all greatest. If notes are governed by the new sovereign CACs have already noteholders, even those who vote sovereign's home law, the sovereign been included by Kazakhstan, with against the changes. is able, subject to constitutional and other countries expected to follow other constraints, to change that law Without a CAC, a sovereign would be shortly. to impose collective action provisions very unlikely to achieve one hundred The IIF has also welcomed ICMA's on noteholders. Greece did this in per cent acceptance of any proposal, recommendations, commenting that 2012, passing a law that applied a whether because a minority of they are fully consistent with the IIF's collective action requirement to its noteholders object to the offer or Principles for Stable Capital Flows existing Greek law governed notes. because some simply do not respond, and Fair Debt Restructuring, the However, as the IIF has noted: and would therefore be likely to face voluntary, market-based code of some creditors continuing to demand "Retroactive legal changes to conduct for sovereign debt payment on the original terms unilaterally modify the terms and

New ICMA sovereign collective action and pari passu clauses 3

(holdout creditors). Through the use in contrast, the holders of the vast Multiple series, single of a CAC, the requisite majority of majority of Greece's debt, who limb voting noteholders can approve accepted Greece's restructuring offer, modifications or other actions with suffered a significant haircut. This represents the most radical respect to their notes in a manner that development in CACs. Use of this The possibility of noteholders in some will bind all noteholders, thereby method allows a proposal for any series gaining an advantage in this removing the threat of holdout modification or action with respect to way could make other noteholders creditors. multiple series of notes to be reluctant to vote in favour of a approved in a single vote amongst the ICMA's CACs set the required restructuring package. holders of all notes affected by the majority for significant changes (eg proposal. The majority required is 75% the dates, amounts and currency of Multiple series, two limb of the aggregate principal amount payment) at 75%. As with the voting outstanding of all the affected series. majorities required for each of the This method broadly follows the form The protection for noteholders, other means of restructuring, this 75% of the euro area's CAC (though, for against a majority imposing on any majority is calculated by reference to example, the majorities differ slightly), particular series terms that might be the outstanding principal amount of and allows modification or other unfair or oppressive to that series, is the notes, not by reference to those action in respect of more than one that any proposal with single limb who vote. As a result, there is no series of notes at the same time. To aggregated voting must meet the need for a quorum requirement for achieve this, the proposal must pass Uniformly Applicable requirement. noteholder meetings, which would two hurdles have been needed if the majority had This requirement is that the terms been determined by reference to the  holders of at least 66⅔% of the offered to the holders of the notes noteholders who actually voted. aggregate principal amount affected by the restructuring must be outstanding on all series of notes, the same or, at least, involve a choice In order to protect noteholders, notes taken in aggregate, must vote for from the same menu of options. As a held by or on behalf of the issuer, by the restructuring, and result, the holders of notes in a series or on behalf of any person owned or that form an overall majority cannot  the holders of at least 50% of the controlled by the issuer or by any vote that their series should receive, aggregate principal amount public sector instrumentality of the say, new notes equal to 80% of the outstanding on each individual issuer are excluded from the face value of their existing holding series of notes must also vote in calculations. The sovereign cannot while other series receive only 1%. vote for its own proposal, which favour. The Uniformly Applicable requirement remains the prerogative of The requirement for majorities across does not mean that a net present independent noteholders. both the notes as a whole and within value calculation must be made in each series offers protection to The risk to a sovereign using single order to ensure that the financial noteholders. A majority of the series modification, particularly for a outcome for the holders of each sovereign's noteholders as a whole small series trading at a discount, is series of bonds is identical. That cannot force on an individual series that an investor may be able relatively would have been complicated given terms that are unacceptable to the cheaply to buy a blocking minority (25% the infinite number of possibilities and majority of the holders of that series. plus one) in the notes. If so, the would leave a risk of disputes. Rather investor can prevent acceptance of The need for a majority within each it means that, after the restructuring, the sovereign's restructuring offer, series of notes leaves the risk that an all noteholders must hold the same even if a majority agree to it. investor could buy a bare majority of a instruments (or have had the option to This happened with some series of particular series of notes in order to hold the same instruments). block the restructuring. This will be a notes issued by Greece and governed Single limb voting is most likely to be harder and more expensive task than by foreign law. Rather than default on of use when noteholders are offered with single series modification. The these notes, Greece paid the holders new notes in exchange for their sovereign can avoid this risk through in full (giving the holders a large profit existing notes or a choice from the if they bought the notes at a discount); the use of single limb voting.

4 New ICMA sovereign collective action and pari passu clauses

same menu of new notes. The count the votes and calculate the face practice, if, for example, the sovereign Uniformly Applicable requirement amount of new notes issued. felt that zero coupon long dated note does, however, allow for different issuances should receive treatment Under both multiple series, two limb series of notes to be amended different from simple interest bearing voting and multiple series, single limb provided that the result of the notes that were issued with a shorter voting, the sovereign may choose to amendments is that the amended maturity. proceed on a sub-aggregated basis instruments have identical provisions. by activating the provisions separately In practice, amendment is likely to be Use of the options in in respect of two or more separate useful only in those cases where a ICMA's CACs series notes drawn from the larger small number of very similar note group of all series of notes which may A key feature of ICMA's CACs is the issues are being restructured. be aggregated (ie the sovereign could flexibility they offer sovereigns. In In order to calculate the par value of aggregate issues A, B and C, the order to achieve a comprehensive notes for these purposes (and for holders of which would vote together, restructuring, a sovereign must voting purposes), the same whether on a single or two limb basis, decide which of the means offered by methodology must be used for all the and, separately, aggregate issues D, ICMA's CACs is appropriate to its series involved (the same applies to E and F, the holders of which would circumstances, including the two limb voting). So, for example, if vote together). Those sub- possibility of using two, or even all notes are in different currencies, the aggregated transactions could three, of the means offered at the same conversion date to a common proceed simultaneously. This same time. What is appropriate will currency should be used in order to approach could prove to be useful in depend upon the circumstances faced

Practical aspects of using ICMA's new sovereign CACs Questions that can arise as to the use of ICMA's new sovereign CACs include the following: Governing law ICMA's sovereign CACs have been drafted on English law lines, but they can be used with minor adaptation for issues governed by New York law. English or New York law is used in almost 90% of international sovereign bond issues. The CACs can, however, also be used for issues under other governing laws, including the sovereign's own law. Legal advice is required with regard to any note issue. Drafting Most note issues are based on the documents used last time by the same issuer, often with considerable resistance to change. ICMA's sovereign CACs can generally be slotted into existing documents without any need to re- draft radically the rest of the terms, particularly as the CACs are based on ICMA's commonly-used 2004 CACs in order to ease transposition. Instruments ICMA's CACs can be used both in individual series of notes and in MTN programme documentation. Extent of usage ICMA's sovereign CACs can be used for some issues but not others. However, the more issues that the CACs are used in, the more powerful the tool becomes. Once a sovereign starts using the CACs, it makes sense to continue to do so. Risk factors Where CACs are used now, it is common to include as a risk factor in an issuing memorandum that the terms of the instrument can be changed by majority vote. Issuers and their advisers will need to consider whether a risk factor on these lines is required for ICMA's sovereign CACs. This will depend upon, for example, the credit position of the issuer, the extent of the use of CACs and other factors. Past experience tends to show that the use of CACs in a single series has generally been positive for countries with a good rating, but more mixed for countries with weak ratings; over time, any effect has tended to wear off. Exercise of the options ICMA's sovereign CACs offer the sovereign three options - single series modification, multiple series modification with two limb voting and multiple series modification with single limb voting. The sovereign does not need to choose which option it might use at the time of issue. The aim is to provide flexibility in restructuring, and allow an assessment to be made as to which of these options is suitable at the time the need to restructure arises. Indeed, the sovereign can choose to use all three methods simultaneously with regard to different issues.

New ICMA sovereign collective action and pari passu clauses 5

by the sovereign at the time. setting out those arrangements, and Pari passu clauses say how it is proposing to treat any For example, a sovereign may put a Alongside the publication of its CACs, series of notes that will not be proposal to the holders of multiple ICMA has also published a new included in any particular proposed series on the basis of single limb sovereign pari passu clause that has modification. The notice convening voting and, at the same time, a been drafted to avoid the difficulties the meeting of noteholders must also different proposal to the holders of that Argentina has faced in the New contain this same information. one or more other series. This might York courts. be appropriate if the holders of the This information requirement should Argentina's pari passu clause that other series are domestic banks enable noteholders to assess the was the subject of NML Capital Ltd v which, if they were to receive the financial condition of the sovereign The Republic of Argentina has two terms offered to the other noteholders, and also to see how the holders of elements, split into two sentences. would immediately require other series of notes are to be treated According to the New York courts, recapitalisation by the sovereign in the restructuring, whether or not "[t]he first sentence... prohibits concerned and the resulting financial those other notes are intended to be Argentina, as bond issuer, from drain on the sovereign would worsen aggregated for voting purposes with formally subordinating the bonds by the deal for all noteholders. their own series. issuing superior debt. The second Where any proposal affects multiple Noteholders' committee sentence... prohibits Argentina, as series, the sovereign is required to bond payor, from paying [other] bonds Noteholders can appoint a committee appoint an aggregation agent, who without paying on the [holdout] to represent their interests in certain must be independent of the sovereign. Bonds." It was the second sentence circumstances. If, for example, the The role of the aggregation agent that gave Argentina's holdout sovereign announces that it intends to includes agreeing any methodology creditors the rights they have used to seek a restructuring of its notes, the for the calculation of the par value of such effect in the US, namely the holders of at least 25% of the the notes for voting and exchange ability to prevent Argentina paying the aggregate principal outstanding of the purposes and determining whether bondholders who accepted notes affected can appoint a person any resolution has been passed by Argentina's restructuring without at or persons as a committee to the requisite majorities. the same time paying in full the represent their interests. If this bondholders who did not. Information for happens, the sovereign is required to noteholders engage with the committee in good Whether any particular pari passu faith and to provide to the committee clause has the same meaning and Noteholders should be able to cast the information referred to above, effect as Argentina's depends upon their votes on an informed basis. As subject to any legal restraints (eg its drafting, construed in accordance a result, ICMA's CACs include a insider trading). with its governing law, as well as the covenant that requires the sovereign remedies available in the relevant At the level of 25%, there is the to publish relevant information before courts. There are many subtly possibility that more than one it puts any proposals to the vote. different pari passu clauses in the committee may be formed. In that market. Not all of them - perhaps This information includes a case, the expectation is that a single even very few of them - will be description of the economic and steering group (comprised of interpreted in the same way as financial circumstances that have led representatives from the committees) Argentina's clause, and other to the proposal, as well as a would be formed and the sovereign sovereigns may not have acted in the description of the sovereign's existing would engage with that steering group way that Argentina has done. debts and its policy reform only. programme. The sovereign must also However, in order to put the matter The committee provisions are in the indicate whether it has entered into an beyond doubt, ICMA's new sovereign form of supplementary provisions in arrangement with multilateral lenders pari passu clause clarifies expressly ICMA's CACs. or other creditor groups (eg the IMF that it only includes the first of the two and the Paris Club) and, if possible, elements in Argentina's clause. It provide copies of the documents does not prevent a sovereign issuer

6 New ICMA sovereign collective action and pari passu clauses

from paying one creditor without at Sovereign-Debt-Information/. the same time paying others, ie it The IMF's paper entitled Contacts affects only the ranking of bonds, not Strengthening the Contractual their payment. Deborah Zandstra Framework to Address Collective Partner The IMF has also supported the use Action Problems in Sovereign Debt of modified pari passu clauses in line Restructuring can be found at T: +44 20 7006 8234 with ICMA's new clause. http://www.imf.org/external/np/pp/eng/ E: deborah.zandstra 2014/090214.pdf. @cliffordchance.com Conclusion Jon Zonis No contractual mechanisms can Partner immediately smooth away all the Clifford Chance LLP acted for ICMA T: +1 212 878 3250 difficulties that can arise in sovereign in relation to its new sovereign E: jonathan.zonis debt restructuring. But the use of collective action and pari passu @cliffordchance.com ICMA's new sovereign CACs and pari clauses. passu clause will, over time, facilitate Simon James orderly restructuring processes Partner between sovereigns and their T: +44 20 7006 8405 creditors, and will enable the majority E: simon.james to prevail to the benefit of both sides. @cliffordchance.com As such, ICMA's new contractual enhancements are one giant leap in Andrew Yianni Consultant the right direction. T: +44 20 7006 2436 ICMA's new model aggregated E: andrew.yianni collective action clauses and pari @cliffordchance.com passu clause can be found at http://www.icmagroup.org/resources/

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