In
finance
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
, a holdout problem occurs when a
bond
Bond or bonds may refer to:
Common meanings
* Bond (finance), a type of debt security
* Bail bond, a commercial third-party guarantor of surety bonds in the United States
* Chemical bond, the attraction of atoms, ions or molecules to form chemica ...
issuer is in
default or nears default, and launches an
exchange offer
An exchange offer in finance, corporate law and securities law, is a form of tender offer in which securities are offered as consideration instead of cash.
In a bond exchange offer, bondholders may consensually exchange their existing bonds for ...
in an attempt to restructure debt held by existing bond holders. Such exchange offers typically require the consent of holders of some minimum portion of the total outstanding debt, often in excess of 90%, because, unless the terms of the bond provide otherwise, non-consenting bondholders will retain their legal right to demand repayment of their bonds at par (the full face amount). Bondholders who withhold their consent and retain their right to seek the full repayment of original bonds, may disrupt the restructuring process, creating a situation known as the holdout problem.
The contractual terms for obligating all bondholders to accept a restructuring approved by some supermajority is typically spelled out in what are known as
Collective Action Clauses, or CACs. In some jurisdictions, CACs or their equivalents are required under local law, but this is not a universal practice. CACs can represent additional borrowing costs for lenders while conversely, borrowers may seek lower debt costs without CAC protection but this exposes them to holdout conditions and potential damaging and expensive litigation which in the case of post-2001 Argentina essentially locked that country out of access to conventional international financing.
The "holdouts" gamble that the restructuring will take place despite the lack of their consent, potentially leading to full repayment of their bonds, while other bondholders receive reduced payments according to the terms of the restructuring. If the restructuring does not take place, they gain nothing, but holdouts may initiate damaging litigation that results in extremely high costs in direct and indirect economic injury to the debtor.
The claims of the holdouts may be insignificant enough, and bothersome enough, that the issuer may satisfy them in whole simply not to be bothered.
Where bondholders are widely dispersed, as is often the case, it can be difficult to contact many holders. Further, many holders of small amounts of bonds have little incentive to invest the time and energy in evaluating the terms of the exchange offer. These factors represent substantial difficulties in obtaining the minimum consent levels.
Holdout problem in sovereign debt restructuring
If countries face the danger of default, additional complications might occur and increase the Holdout problem:
National pride
Governments fear damages of their status as an advanced economy, which could lead to increasing sovereign bond yields. As an example, during the
Eurozone crisis
The euro area, commonly called eurozone (EZ), is a currency union of 19 member states of the European Union (EU) that have adopted the euro (€) as their primary currency and sole legal tender, and have thus fully implemented EMU policies. ...
the former French president
Nicolas Sarkozy
Nicolas Paul Stéphane Sarközy de Nagy-Bocsa (; ; born 28 January 1955) is a French politician who served as President of France from 2007 to 2012.
Born in Paris, he is of Hungarian, Greek Jewish, and French origin. Mayor of Neuilly-sur-Se ...
said: “we will show that Europeans pay their debt”. Sarkozy aimed declining bond yields with his statement, but showed implicitly that countries want to avoid sovereign debt restructurings concerning their own national pride.
Sovereign debt restructuring could be tantamount to an admission of emerging market status.
Contagion
In
currency union
A currency union (also known as monetary union) is an intergovernmental agreement that involves two or more State (polity), states sharing the same currency. These states may not necessarily have any Economic integration#Stages, further integratio ...
s (such as the
Eurozone
The euro area, commonly called eurozone (EZ), is a currency union of 19 member states of the European Union (EU) that have adopted the euro (€) as their primary currency and sole legal tender, and have thus fully implemented EMU policies ...
) the effect of complex economic relationships could possibly lead to a conflagration. A debt restructuring of numerous countries or one great country might destabilize the global banking industry.
Relationship between sovereign debt and private sector
In the majority of countries, a substantial part of
sovereign bonds
A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments'','' and to repay the face value on the maturity date ...
is likely to be held by
financial institution
Financial institutions, sometimes called banking institutions, are business entities that provide services as intermediaries for different types of financial monetary transactions. Broadly speaking, there are three major types of financial insti ...
s in the sovereign's own country (like banks, insurance companies and pension funds). Restructuring those instruments will therefore undermine the health of the domestic financial system. Even if countries are able to reduce significantly their costs of debt service, the same amount might need to be spent in bank recapitalizations.
Feasibility
Creditors left behind in a restructuring could lead to following problems:
* If there are enough of them, the financial predicates underlying the entire restructuring may be undone.
* If holdouts are subsequently paid in full, it makes the participating creditors look deprived and this leads in the next restructuring to even more holdouts.
* If holdouts are not paid after the restructuring closes, they pose an ongoing
litigation
-
A lawsuit is a proceeding by a party or parties against another in the civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today. The term "lawsuit" is used in reference to a civil actio ...
and attachment threat to the debtor, e.g. Argentina’s decade-long legal fight with thousands of holders of the Argentine bonds that went into default in 2001.
European Stability Mechanism
The
European Stability Mechanism
The European Stability Mechanism (ESM) is an intergovernmental organization located in Luxembourg City, which operates under public international law for all eurozone member states having ratified a special ESM intergovernmental treaty. It was ...
(ESM) has been installed in order to help out countries of the
Eurozone
The euro area, commonly called eurozone (EZ), is a currency union of 19 member states of the European Union (EU) that have adopted the euro (€) as their primary currency and sole legal tender, and have thus fully implemented EMU policies ...
in financial distress. In case of an ESM-approved sovereign debt restructuring, the Holdout problem might play a significant role. Following amendments to the ESM could reduce this problem:
* Ensuring that the financial support being provided by the ESM to one of its members is not diverted to the repayment of an existing debt obligation of that member that was eligible to participate in a debt restructuring but declined to do so
* Assisting the beneficiary member state in any ESM-approved restructuring of its debt by deflating the expectations of prospective holdouts that they will be able to extract a preferential recovery through the pursuit of legal remedies after the restructuring closes
* Providing a safe harbor in the
Eurozone
The euro area, commonly called eurozone (EZ), is a currency union of 19 member states of the European Union (EU) that have adopted the euro (€) as their primary currency and sole legal tender, and have thus fully implemented EMU policies ...
for the recipient state to hold its assets and conduct its financial affairs without fear of harassment by holdout creditors
Recent examples
Peru
Successful litigations were undertaken by some holdouts in
Peru
, image_flag = Flag of Peru.svg
, image_coat = Escudo nacional del Perú.svg
, other_symbol = Great Seal of the State
, other_symbol_type = Seal (emblem), National seal
, national_motto = "Fi ...
(1996).
Argentina
A similar dispute between
Argentina
Argentina (), officially the Argentine Republic ( es, link=no, República Argentina), is a country in the southern half of South America. Argentina covers an area of , making it the second-largest country in South America after Brazil, th ...
and holdouts has been ongoing since at least the 2005
Argentine debt restructuring
The Argentine debt restructuring is a process of debt restructuring by Argentina that began on January 14, 2005, and allowed it to resume payment on 76% of the US$82 billion in sovereign bonds that defaulted in 2001 at the depth of the worst ...
.
Bondholders that accepted the 2005 swap (two out of three did so, while accepting only about one-third of the bond value in the restructuring) saw the severely reduced value of their bonds rise 90% by 2012, and these continued to rise strongly during 2013.
An August 2013
appeals court
A court of appeals, also called a court of appeal, appellate court, appeal court, court of second instance or second instance court, is any court of law that is empowered to hear an appeal of a trial court or other lower tribunal. In much of ...
ruling in ''Argentina v. NML Capital'', 12-1494, determined that holdouts should be repaid the full face value, but without the losses taken by those who had accepted the 2005 and 2010 swaps at a 70%-75%
discount.
[ In October 2013 the Supreme Court affirmed the decision without comment. A second decision of the 2nd Circuit which prohibits payments to creditors who did accept the swap if holdouts are not paid was on appeal to the full panel as of October 2013. This case may also be appealed to the Supreme Court. Enforcement of the decisions is stayed pending a final Supreme Court decision.] Courts in Belgium, France, and Germany have backed Argentina on the basis of the equal terms clause, however. The lack of legal certainty Legal certainty is a principle in national and international law which holds that the law must provide those subject to it with the ability to regulate their conduct.
The legal system needs to permit those subject to the law to regulate their condu ...
is U.S. courts prompted Argentine officials to propose placing the restructured bonds in question under Argentine law, while concurrently announcing a renewed bond swap offer.[ However, court decisions outside the US had no bearing on Argentina's debt obligations, since Argentina had sold their debt under US law.
The possibility that holdout creditors can attach future payments on restructured debt and receive better treatment than cooperating creditors distorts incentives and can derail efforts for a cooperative restructuring.][ It is likely to be of particular importance in cases in which the creditors are being asked to accept substantial debt and debt service reduction. However, it is unclear given the special circumstances of the Elliot case whether it will be broadly applicable to holdouts in other restructurings.] The new Argentine government elected in late 2015 gave indications of its willingness to negotiate with the set of thousands of holdout creditors. The Argentine situation has increased awareness of the utility of Collective Action Clauses in preventing or reducing holdout complications in debt restructuring.
See also
*Debt restructuring
Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continue ...
*Troubled Debt Restructuring A troubled debt restructuring (TDR) is defined as a debt restructuring in which a creditor, for economic
or legal reasons related to a debtor's financial difficulties, grants a concession to the debtor
that it would not otherwise consider. As suc ...
*Vulture fund
A vulture fund is a hedge fund, private-equity fund or distressed debt fund, that invests in debt considered to be very weak or in default, known as distressed securities. Investors in the fund profit by buying debt at a discounted price on a ...
References
{{Reflist
External links
The problem of sovereign debt restructuring
(PDF) by Kentaro Tamura
International Monetary Fund
Bonds (finance)