Re-designing Pacman: The Impact of the Recent Argentinian Bond Workout on the Future of Sovereign Debt Restructurings
The outbreak of COVID-19 has affected negatively the economic and financial stability of the global economy. Developing countries, in particular, seem to have faced exceptionally dire conditions as the pandemic has further exacerbated existing macro-economic pressures. In an attempt to combat such pressures, Argentina restructured almost $65 billion in sovereign bonds in September 2020, with over 90% approval from its bondholders. The restructuring itself is rather historic because it was the first time that the robustness of the model Collective Action Clauses drafted by the International Capital Markets Association (ICMA) was tested. Argentina sought to adopt two controversial strategies (appropriately dubbed ‘re-designation’ and ‘Pacman’) in order to circumvent the requirements of these clauses but this was met with an impassioned uproar from some of the bondholders. In the end, Argentina reached an agreement with its largest bondholder group and agreed to make certain changes to these controversial strategies so that it can successfully pass the much-needed restructuring resolution.
Image of Buenos Aires - the pandemic has exacerbated existing macro-economic pressures
Collective Action Clauses (CACs) are indenture terms, commonly used in sovereign bonds, that allow a supermajority of bondholders to bind a dissenting minority in bondholder resolutions. Such clauses are seen as crucial to bond restructurings because they address the need for the issuer to locate and negotiate with each individual or entity with interests in their bonds. Due to the international appeal of sovereign bonds, such interest holders could be many and might also be located across the globe which would make a restructuring more timely and expensive. Following years of back-and-forth alterations to CACs in sovereign bonds, the ICMA published its standardised CACs in 2014 (revised in 2015). These CACs included the appropriate features of previous CACs used in similar sovereign restructurings and further attempted to rectify their problems. The ICMA model permits three ways to modify the payment and other key terms (known as the ‘Reserved Terms’) of sovereign bonds:
a) a series-by-series option that requires a 75% approval from each series of bonds;
b) a ‘two-tier’ option which requires 66 and 2/3% approval from all the bonds in an aggregated pool AND a 50% majority in each series in the aggregated pool;
c) a ‘single-limb’ option that requires a 75% majority from all bonds in the aggregated pool but this method can be used ONLY IF the proposed modification is ‘Uniformly Applicable’ to all the affected series. ‘Uniformly Applicable’ means all series must be offered the same new instrument or other consideration OR they must be allowed to select from the same menu of new instruments.
The issuer has complete discretion to choose which of the three options to use and which bonds and/or series of bonds to restructure although once this aggregate pool has been chosen, it is final for the purposes of that modification process (the ‘finality’ condition). It should further be noted that the language of the two-tier modification method seems to suggest that if the sovereign was unable to get a 50% approval from one of the series, then the entire restructuring fails (the ‘all-or-nothing’ condition). This might grant a small series of bonds, which only represents a minute portion of the aggregate pool, a disproportionately larger blocking power. These two features of the ICMA model CACs were the driving force behind the recent decision of the Argentinian government to propose the controversial ‘re-designation’ and ‘Pacman’ strategies.
‘Re-designation’ occurs when an issuer changes the voting pool after the votes have been cast and counted (so after the restructuring resolution has passed). Argentina sought to use the strategy in order to circumvent the ‘finality’ condition, as well as the requirements of the ‘two-tier’ modification method which it elected to use in order to ensure a successful restructuring on at least some of its sovereign bonds. This strategy would further allow Argentina to lower the voting thresholds required under the ‘two-tier’ modification method since voting on the use of ‘re-designation’ is considered a ‘Non-Reserved’ matter and as such only requires a 50% approval from the initial aggregated pool.
‘Pacman’ occurs once the initial restructuring (Round 1) has taken place and a subsequent offer has been made to alter the terms in those dissenting bonds that were ‘re-designated’ in the initial restructuring round (Round 2). Such a subsequent offer would pool the dissenting bonds with the already restructured bonds (or with newly issued bonds) and then offer the same or slightly improved terms than those offered in the first round of restructuring. If, for example, the sovereign pools the initially restructured bonds with those dissenting bonds and then offers all a marginal increase in interest payments, it virtually guarantees that it will have a significant supermajority since all bondholders holding the restructured bonds from Round 1 are likely to accept this marginal increase in interest payments. With a majority of over 75% and bond modification terms that are offered to all bonds in this subsequent restructuring round, the sovereign can now use the third ICMA model CACs modification method to bind those dissenting bonds that were excluded from the voting pool in Round 1.
It should not come as much of a shock that these two strategies caused widespread furore. In cases where Argentina would substantially reduce the number of series of bonds in the pool, some bondholders could argue that this would mean their bonds will lack sufficient market liquidity and bondholders might also be concerned about any holdouts that could decide to litigate, thus posing a risk to the participating bondholders. This was the case in NML v Argentina where holdout creditors managed to get an injunction that precluded Argentina from making interest payments due to those non-holdout bondholders.
In NML v Argentina holdout creditors managed to get an injunction that precluded Argentina from making interest payments due to those non-holdout bondholders.
In the end, Argentina negotiated with its creditor groups and a consensus was reached. It was agreed that Argentina could ‘re-designate’ if EITHER bondholders were given 5 days’ notice to withdraw their bond tenders once they were told which series of bonds were to be excluded OR if a majority of 66 and 2/3% of the initial voting pool approved the use of this strategy (rather than the reduced threshold of 50% for ‘Non-Reserved’ matters). ‘Pacman’ was then agreed to be utilised only if its use was approved by a 75% majority of the initial pool of bonds AND the subsequent offer had terms that are ‘Uniformly Applicable’ to all bonds in the new pool. If Argentina could not get this 75% majority, there would be a ban of 36 months on the use of the ‘Pacman’ strategy.
This most recent Argentinian sovereign bond restructuring can be said to have demonstrated that perhaps certain provisions in the ICMA model CACs might benefit from a redraft. The two provisions that ‘re-designation’ and ‘Pacman’ strategy to circumvent are the all-or-nothing condition of the two-tier modification method (i.e. if the sovereign cannot reach the 50% threshold in even a single series, then the entire restructuring fails) and the ‘finality’ condition. The ‘finality’ requirement is not present in the ICMA recommended language for bonds governed by English law and it does not seem readily apparent why the recommended provisions for bonds governed by New York law is more restrictive. Similarly, it is unclear why a single series of bonds in an ICMA model CAC two-tier modification method can potentially block an entire restructuring resolution where one of the main concerns of ICMA drafters was, in fact, the threat that minority holdouts can pose to a restructuring that has substantial majority backing. Until the ICMA drafters have a chance to review their recommended CACs, the available tools that are at a sovereign’s disposal remain ‘re-designation’ and ‘Pacman’. Despite their controversial nature, the changes made to those strategies in the recent Argentinian and Ecuadorian workouts seem to have the approval (or at least the acquiescence) of the international bondholder community.
By Tsano Kanchev
