Eurozone Introduces Collective Action Clauses on Government Bonds

From this week, all newly-issued government bonds issued in the eurozone must carry collective action clauses (CACs), making the region the first developed market to impose such clauses routinely.

The effect of CACs, which took effect in the eurozone from 1 January 2013, will be to allow a two-thirds majority of bondholders who agree to a restructuring to force any dissenting minority to participate. As a result, everyone will have to share the pain equally should any government follow a similar path to Greece and need to cut its debt burden radically to avoid defaulting.

Applying CACs, which can force investors to accept big losses on their bond holdings, acknowledges that a developed country can go bankrupt and debt default is no longer the preserve of emerging market governments. The aim is to make it easier and less costly for a government to restructure its debt. At the same time, the measure could, under certain conditions, create a two-tier market, with bonds not covered by the new regime worth more. In 2003 the Group of Ten (G10) major industrialised nations made CACs the norm for most emerging market bonds issued under international law.

A decade ago no G10 member included CACs in their domestic legislation, regarding a developed country bankruptcy as all but inconceivable.  “[The G10] did not particularly perceive the CAC provision to be of relevance for themselves,” said David Hiscock, senior director for market practice and regulation policy at the International Capital Market Association.

“It was more aimed at emerging countries issuing debt under international law, such as Mexico. Recent times have suggested maybe life is not as simple as that, certainly in the eurozone.”

After three years of crisis in the region, the eurozone has good reasons for inserting the clauses. An absence of CACs on many Greek bonds allowed hedge funds to make big profits by avoiding a write-down of the country’s privately-held debt last year. Greece retroactively inserted CACs into its domestic bonds to enable a successful swap last March although it still has €6.4bn of foreign law bonds, the terms of which can’t be altered.

The scale of debt to be covered by CACs has steadily increased since they were first debated. Anna Gelpern, a professor of law with the American University Washington College of Law, who has researched CACs for the past 15 years, said that “the debate about including CACs was about a US$300bin market”.

However, with the eurozone adopting them, that sum could top US$10 trillion in 10 years when the region will have rolled over most of its current bonds. “We’re entering a new era when [developed market] money can be restructured,” Gelpern said.

Over time this could lead to a two-tier market in euro zone bonds: those subject to CACs, which could impose losses on holders, and those without, whose holders – as happened in Greece – just might be repaid in full. According to ING, all but about 15% of current bonds without CACs will have expired in a decade, meaning most debt outstanding then will carry the clauses.

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