Sovereign Debt Writedowns Draw Closer in Franco-German Plan

(Bloomberg) -- France and Germany want to make it easier to restructure bonds of euro-area nations that get into trouble.

A joint proposal, released Tuesday, envisages the start of talks on strengthening collective action clauses, which have been mandatory for sovereign bonds issued by euro-area states since 2013. The new procedure would kick in when a member of the currency bloc seeks financial assistance from its crisis-fighting fund.

Rules currently in place allow repayment modifications if the terms are approved by two sets of majorities. Holders of all the affected bonds voting together must approve changes, as must holders of each bond series separately. Replacing this cumbersome “two-limb” voting procedure with a single-limb aggregation clause requiring a single vote by holders of the affected bonds would make it harder for holdouts to resist debt restructuring attempts when the majority of investors concedes that it’s necessary.

The Franco-German proposal also calls for the European Stability Mechanism to “facilitate” dialog between member states and private investors, when changes to repayment terms are sought. While this provision is similar to what the International Monetary Fund currently does for countries seeking assistance, the ESM will have a tighter grip on the process because its lending power in euro-area bailouts is a multiple of the IMF’s capacity.

“This proposal mis-diagnoses the problem, which is European procrastination over debt relief,” said Gabriel Sterne, head of global macro research at Oxford Economics in London. “No creditor ever wants to give debt relief, so you need a neutral referee to assign losses. That should be the IMF, but they haven’t done their job properly. The Europeans already have too much power, they’ve demonstrated they abuse it, and this gives them more.”

The joint proposal softens the initial position of countries including Germany and the Netherlands, which called for automatic upfront debt restructuring for euro-area states seeking ESM loans. That plan, if adopted, would risk causing panic and a run on the bonds among investors at the first sign of trouble.

By facilitating the process while stopping short of making it automatic, the compromise could address concerns of Northern European voters, while not scaring off investors when troubled countries contemplate seeking a bailout.

©2018 Bloomberg L.P.

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