- Notes minority of bondholders can move to stall restructuring negotiations due to clause
A clause on some of Sri Lanka’s older dollar bonds gives creditors a potential opening to hold the sovereign nation hostage and stall restructuring negotiations, warned Lee Buchheit, a veteran of over two dozen debt restructurings who has also been consulted by the Sri Lankan Government. He reminds that some of the nation’s debt contracts contain the so-called single series collective action clause, which could allow a minority of bondholders to veto or demand terms in the negotiations.
“One must always anticipate the possibility of holdout creditors in an operation of this kind,” Buchheit had said via email. “No one seriously doubts that Sri Lanka needs debt relief. The debate may focus on how much debt relief and from whom it will be sought.”
While Sri Lanka is seeking a bailout from the International Monetary Fund (IMF), the multilateral lender insists that existing debt must be brought to sustainable levels before any aid is doled out. That could include protracted discussions with not just global asset managers but also large bilateral creditors such as Japan, India, and China, each of whom would also impose their conditions.
For instance, India has stated that it wants China to be treated on par with other creditors in the debt restructuring process. However, China has historically preferred to hand out fresh loans as refinance rather than rework existing debt, and doesn’t often share details of the credit. Sri Lanka hasn’t been able to tap a $1.5 billion swap line from China over concern that the IMF may consider it as a loan and force delays in repayment.
‘Main challenge’
“The main challenge I see is one of co-ordination among the three main creditor groups – bondholders, Paris Club bilaterals, and non-Paris Club bilaterals like China and India,” said Buchheit. “A commitment by Sri Lanka to even-handed treatment of these three groups should go a long way toward smoothing the path of the negotiations.”
China has indicated that it will not insist on preferential repayment of loans and is willing to be treated on par with other creditors, Sri Lanka’s President Gotabaya Rajapaksa said in an interview on Monday (6).
When asked if Beijing would be willing to be treated on par with other creditors, Foreign Ministry spokesman Zhao Lijian said on Tuesday (7) that China supports “the proper settlement through consultation with relevant parties and institutions” and hopes other countries will also play a constructive role. “We hope that Sri Lanka will protect the legitimate rights of foreign investors and safeguard and uphold the credibility and good investment environment at home,” he added.
The island nation is grappling with a worsening humanitarian crisis after it ran out of dollars to import food and fuel, stoking inflation to 40% and forcing a historic debt default. Sri Lanka needs $ 5 billion to ensure “daily lives are not disrupted,” and a further $ 1 billion to strengthen the rupee, Prime Minister Ranil Wickremesinghe told parliament on Tuesday.
The first step would be a Debt Sustainability Analysis from the IMF, which will provide an outline of how much of a haircut creditors could see. Unlike corporate bankruptcies, debt restructuring has no clear, defined rules.
That’s where Buchheit fits in. The retired lawyer has worked on almost every major sovereign restructuring case in a career that spanned over four decades, including leading the legal team for the $ 206 billion Greek negotiations in 2012. That restructuring – the world’s biggest – retroactively imposed an “aggregated collective action clause (CAC)” across domestic notes, which has since become an important tool to ensure that a majority of creditors can force any minority holdouts to accept a restructuring deal.
Bonds issued before 2015 are likely to be subject to the problematic single-series CACs as innovations after that year have eliminated more protracted negotiations by requiring only investors who hold three quarters of overall debt to agree, according to Matthew Vogel, London-based Portfolio Manager and Head of Sovereign Research at FIM Partners.
Sri Lanka’s 5.875% bond maturing in July was issued in 2012, while the 6.85% notes due 2025 and the 6.125% 2025 bond were sold in 2015. The bond maturing in July was indicated up 0.4 cents to 43.9 cents on the dollar on Tuesday, while the most traded 7.55% 2030 bond dropped 0.7 cents to 38.2 cents on the dollar.
“This particular restructuring is going to be very fraught,” said Vogel. “Current prices for the debt imply recovery values are going to be very low.”
(Bloomberg)
