The Looming Debacle of New York’s Sovereign Debt Bills

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Gregory Makoff is a senior fellow at the Mossavar-Rahmani Center for Business and Government at the Harvard Kennedy School and author of Default.

Revising the rules of the sovereign debt restructuring game is not simple. For example, adding “collective action clauses” to sovereign bond contracts to deter holdout creditors took 20 years.

The idea was first proposed after the Mexican crisis of 1994, an initial form was adopted in 2003 after Argentina’s 2001 default on nearly $100 billion in bonds, and sufficiently powerful clauses were only adopted in 2014, following Argentina’s complicated litigation in the New York courts. and the debt crisis in Europe.

Yet New York is under pressure to do something radical in just a few months. This could cause serious problems for the sovereign debt market.

Here’s what’s happening: Last year, three groups of senators and Assembly members proposed competing laws to favor sovereign debtors over their creditors. The campaign for the law was initiated by social activists and legislators angered by Puerto Rico’s debt problems, but it broadened and gained energy when Washington-based Jubilee activists took action. joined to the effort.

Capturing the mood in Albany, New York State Senate Finance Chair Liz Krueger said at a recent press conference:

This is an international problem that is destroying the people of other countries. And too many of these stories begin and end with New York and New Yorkers.

The rationale put forward for these three laws is that poor countries are too weak to trade on their own against sophisticated investors, and that aggressive hedge funds are taking advantage of poor countries in New York courts. The draft bills, however, are more a reserve of ideas than a coherent and well-calibrated solution to the problems raised.

The first bill would add a bankruptcy-like debt adjustment mechanism to sovereign debt issued under New York law. The second would limit the judgments available to creditors to a level established by bilateral lenders in corresponding international debt negotiations. A hedge fund holding a New York law bond, for example, would not be able to obtain a court judgment in excess of the value that the United States had accepted in exchange for its defaulted loans during a negotiation in Paris Club.

The third bill would restore to New York state law the champerty defense for sovereign defaulters, which the legislature removed for claims over $500,000 in 2004. With the reinstatement of this provision, the Court judgments would be blocked on debts that were purchased with the “intent and purpose” of suing.

Major law firms are questioning the legal merits of the first bill, the proposed sovereign bankruptcy mechanism under New York law. Under the U.S. Constitution, bankruptcy laws must be enacted only by the U.S. Congress, and only federal courts hear bankruptcy cases. The proposed law, however, would require the governor of New York to appoint a “monitor” for sovereign debt restructuring, allow the debtor country to “seek relief from the state” and allow the country to file a “plan” with the State. New York State will adjust its debt.

Furthermore, this ambitious project lacks details, not even identifying a specific court to adjudicate disputes, although disputes will inevitably arise on day one. While purporting to add a collective voting mechanism to New York law, nowhere in the law or supporting documents is there any discussion of how the new mechanism would operate alongside the collective action provisions that are now already included in most sovereign bonds.

The second bill, which caps private creditor judgments, is also poorly designed. On the one hand, its scope is too broad: it applies to all borrowers, whereas a similar law passed in the United Kingdom in 2010 only applied to countries with a GDP per capita of around 1 500 dollars. Second, it could be open to abuse, as it would allow the US Treasury to dictate the ceiling for private creditors, even when bilateral creditors do not have enough leverage. The Treasury could, for example , dictating terms even when private creditors provided 98 percent of the debt concerned and bilateral creditors only 2 percent.

The third bill is less threatening in that champerty has long been part of New York State law and its effects are known. Part of the reason for the need for a law is that an exception was included in the law in 2004 to protect holders of debts over $500,000, which benefited investors intending to resist sovereign debt restructurings. The proposed bill would remove this exception with respect to sovereign debts. The effectiveness of champerty against procedural investors was proven in 1998, when Peru successfully used a champerty defense against Elliott Associates in district court, although that defense was overturned on appeal.

Still, the bill’s current wording could surprise conventional investors. To operate without disrupting the market, it would need to provide an unambiguous “safe harbor” provision, such that it applies only to investors who intend to sue, and exempts regular buy-and-hold investors and distressed debt investors with a history of cooperating in sovereign debt restructurings.

Creditors and legal experts are stunned that legislative leaders have lined up behind a merger of the first two bills, the ones with the most problems, with activists and lawmakers announcing at a March 13 news conference their intends to pass the merged law by June.

Creditors are furious that feedback they have provided over the past year has apparently been completely ignored. They say the bill would increase the cost of financing for poor countries, and they have threatened to move the sovereign debt market to Texas, Delaware or another jurisdiction that will not try to change the laws without consultations. .

Opting for a vote with poorly written bills and a hot market would be a regrettable mistake. What is needed is an open conversation and enough time for the legislature to craft a workable bill. The next step is expected to be for the New York State Senate Finance Committee to announce hearings on the proposed laws. Supporters and opponents, the IMF and the US Treasury should be invited to testify, as should finance ministers from developing countries, who do not appear to have been consulted on any of the bills.

Although holding hearings could push passage of the bill beyond June, they are a necessary step if lawmakers are to pass a bill supported by debtors and creditors in the sovereign debt market . It is important to note that the trade-off is possible: most investors dislike aggressive holdout investors because they disrupt the market, which is why investors accepted strong CACs in 2014 that block holdouts. If it changes course, New York lawmakers could achieve successful reform.

New York lawmakers should keep in mind, however, that even the final CAC improvement in 2014 took the U.S. Treasury two years to achieve. But a decade later, those two years seem short. Today, around 80% of all sovereign bonds include these new clauses, and two major debt restructurings in 2020 – for Argentina and Ecuador – used these new clauses. This reform was a huge success and the new clauses were accepted by the market at no additional cost to sovereign borrowers.

But this result wasn’t a matter of luck or good timing; rather, it was the result of careful analysis and extensive global consultations with sovereign debtors and creditors. New York state lawmakers should learn from this experience and slow down, invite debate, and design a new, more carefully calibrated law.

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