Repo Markets Across the Atlantic: Similar but Unalike

By Songjiwen Wu (University of Heidelberg) and Hossein Nabilou (Universite du Luxembourg – Faculty of Law, Economics and Finance)

The vulnerabilities in the wholesale funding and in particular short-term (overnight) repurchase agreement (repo) markets were significant sources of systemic risk in the Global Financial Crisis. Numerous studies have investigated the role of repos in the crisis, but only a few scholars have explored why the European repo markets have weathered the crisis better than their US counterparts. With a focus on the underlying legal and structural features of repo markets across the Atlantic, our paper sets out to explain such a different outcome. In doing so, it sketches the key differences in the EU and the US repos by focusing on three main aspects of repo markets that are pivotal to highlighting potential vulnerabilities. First, it highlights the differences in the legal framework governing repos, such as legal construction of repo contracts, special bankruptcy treatment—the reform of which has been a key controversial issue across the Atlantic—and legal treatment of the reuse of collateral. Second, it discusses the composition, structure, and organization of the repo markets, such as differences in the composition of repo participants, maturity of repos, and the composition of the underlying collateral in repo contracts. Finally, it investigates the differences in the issues related to the market infrastructure of repo markets such as differences in the clearing and collateral management stages. The findings of our paper suggest that multiple legal and regulatory divergences, which could still pose challenges to the short-term funding markets, exist in repo markets across the Atlantic.

The full article is available here.


For previous Roundtable posts on repo markets, see Ganduri, “Repo Regret?“, and Morrison, Roe & Sontchi, “Rolling Back the Repo Safe Harbors“.

Bankruptcy Law as a Balancing System – Lessons from a Comparative Analysis of the Interaction Between Labor and Bankruptcy Laws

By Omer Kimhi (Haifa University Faculty of Law) and Arno Doebert (Independent)

The rehabilitation of distressed corporations often requires the reduction of labor costs. In order to regain economic stability, distressed firms need to terminate employees or modify their employment conditions. When employees are protected by statutes or by collective bargaining agreements, however, such measures are not always possible. The employer’s freedom to manage its work force is limited, and it may fail to implement labor reforms necessary for the firm’s recovery.

In the paper, we examine the intersection between bankruptcy and labor laws from a comparative perspective. We study the labor and bankruptcy laws of three different jurisdictions, the Netherlands, France, and Germany, and find a so far unexplored trend. Jurisdictions with high employment protection levels relax their otherwise rigid labor rules through their bankruptcy system. Within bankruptcy, employers enjoy greater flexibility and thus are better situated to decrease their labor costs and to reorganize.

The paper explores this trend vis-à-vis the arguments brought up by the procedural approach to bankruptcy. It looks at the rationale of the bankruptcy-induced modifications to the labor laws, and the effects these changes have on the bankruptcy process. We show that although the modifications are designed to promote the preservation of firms as going concerns, forum-shopping problems may lead to the opposite outcome. The analysis contributes to the ongoing debate between the traditional and procedural approaches, and sheds light on the interpretation of section 1113 of the Bankruptcy Code as well.

The full article is available here.

 

 

 

Loan to Bond Substitution: An Empirical Analysis on the Functioning of the Substitution Channel for Eurozone Firms

By Francesco Ruggiero (University of Naples Federico II)

This paper contributes to the literature by enhancing the understanding of the link between bank debt and bond market debt in the Eurozone. This implication is particularly important for small firms that usually rely heavily on bank loans, and are likely to be excluded from the credit market during crises. In this paper, I find that firms based in the Eurozone can substitute bonds for loans in response to changing credit conditions. But the substitution is only partial, and firms will end up raising less funds than needed. Despite the bank centric feature of the European financial market that encourages firms to rely a lot on bank loans, bonds still serve as a substitute to loans. Firms in the Eurozone choose to substitute bonds for loans especially in periods in which the banking sector is in distress or the central bank implements policies to enhance credit.

The comparison with the U.S. firms (provided as benchmark) requires an in-depth analysis on the relative roles of the banking system and the financial market in Europe and the U.S. The divergence in results might indicate that policies enacted by the Fed in the U.S. might not be the best fit for European system. European Central Bank (“ECB”)  should thus tackle similar problems differently. In principle, the central bank’s expansive monetary policies should have affected bank lending positively as well. The reason why it did not work as expected along this transmission channel is that  the banks tend to hoard extra liquidity received from the ECB to deal with potential  sudden shortages in the future.

The full article is available here.

 

 

The Impact of Brexit on Debt Restructuring and Insolvency Practice

By Manuel Penades and Michael Schillig (King’s College London – The Dickson Poon School of Law).

With its flexible restructuring framework and experienced courts, England has become the foremost restructuring destination in Europe. A restructuring typically combines a scheme of arrangement with a pre-pack administration. Under the former, lenders exchange their debt for equity or new debt in a new corporate holding structure; the latter facilitates the transfer of the business to this new holding structure. The effectiveness of these restructuring measures in all EU Member States is currently guaranteed by the combined effect of the European Insolvency Regulation (EIR), the Judgments Regulation (Brussels Ibis), and the Regulation on the law applicable to contractual obligations (Rome I).

This regime currently ensures the availability of English-law pre-pack administration and other insolvency procedures to many EU debtors. The EIR ties exclusive jurisdiction and applicable insolvency law to the debtor’s Centre of Main Interests (COMI). Insolvency measures issued by the opening court are automatically recognised and enforced throughout the EU. Subject to a COMI transfer to England, any debtor can benefit from English insolvency and restructuring mechanisms (including pre-pack administration) and their automatic EU-wide effect.

Post-Brexit, the EIR will cease to apply in the UK and insolvencies opened therein will lose their automatic EU effect. English domestic law alone will be insufficient to achieve this result. Only a new international instrument, probably in the form of a convention, could maintain the effectiveness of the current practice.

By contrast, schemes of arrangement are not covered by the EIR and their enforceability across the EU is currently ensured by Brussels Ibis and/or Rome I. The UK will be able to retain the Rome I regime through a unilateral instrument, but not the Brussels Ibis, which requires reciprocity, like the EIR.

Given that schemes and insolvency procedures are usually combined, absent new international instruments, Brexit is likely to result in significant uncertainty and disruption for European restructuring practice.

The article is available here.

How to Restructure Venezuelan Debt

By Lee C. Buchheit (Cleary Gottlieb Steen & Hamilton LLP) & G. Mitu Gulati (Duke University School of Law).

There is a growing consensus that Venezuela will not be able to persist for much longer with its policy of full external debt service. The social costs are just too great. This implies a debt restructuring of some kind. Venezuela, principally through its state-owned oil company, Petróleos de Venezuela, S.A. (“PDVSA”), has extensive commercial contacts with the United States. Not since Mexico in the 1980s has an emerging market country with this level of commercial contacts attempted to restructure its New York law-governed sovereign debt. Holdout creditors in a restructuring of Venezuelan sovereign debt will therefore present a serious, potentially a debilitating, legal risk. The prime directive for the architects of a restructuring of Venezuelan debt will be to neutralize this risk.

The full article is available here.

Deterring Holdout Creditors in a Restructuring of PDVSA Bonds and Promissory Notes

By Lee C. Buchheit (Cleary Gottlieb Steen & Hamilton LLP) & G. Mitu Gulati (Duke University School of Law).

Probably the main reason why the Maduro administration has not attempted to restructure Venezuelan sovereign debt is the potential mischief that may be caused by holdout creditors. The next administration in Venezuela — whenever and however it may arrive — will not want for suggestions about how to minimize or neutralize this holdout creditor threat. One option, before a generalized debt restructuring of some kind affecting all outstanding bonds, is for Venezuela to acknowledge that there really is only one public sector credit risk in the country and that the distinction between Republic bonds and its state-owned oil company, Petróleos de Venezuela, S.A. (“PDVSA”) bonds is artificial, and then to offer to exchange PDVSA bonds for new Republic bonds at par. The question will be, as it always is, how to discourage PDVSA creditors from declining to participate in such an exchange offer.

We suggest that one method might be for PDVSA to pledge all of its assets to the Republic in consideration for the Republic’s assumption of PDVSA’s indebtedness under its outstanding bonds and promissory notes. This is a step expressly permitted by PDVSA’s bonds and promissory notes. Existing PDVSA creditors would be perfectly free to decline to exchange their exposure for new Republic bonds, but they would face the prospect that a senior lienholder (the Republic) would have a first priority claim over any PDVSA assets that the holdout may attempt to attach to satisfy a judgment against PDVSA. That realization should make them think twice about the wisdom of holding out.

The full article is available here.

Venezuela’s Restructuring: A Realistic Framework

By Mark A. Walker (Millstein & Co.) and Richard J. Cooper (Cleary Gottlieb Steen & Hamilton, LLP).

Venezuela is confronting an economic and financial crisis of unprecedented proportions.  Its economy remains on a precipitous downward trajectory, national income has more than halved, imports have collapsed, hyperinflation is about to set in, and the government continues to prioritize the payment of external debt over imports of food, medicine and inputs needed to allow production to resume.  Bad policies are complemented by bad news as oil production and prices have declined dramatically from previous highs.  Financially, the country is burdened with an unsustainable level of debt and has lost market access.  Venezuela will be unable to attract the substantial new financing and investment required to reform its economy without a comprehensive restructuring of its external liabilities.

Given this array of problems, Venezuela and its national oil company, PDVSA, face what may be the most complex and challenging sovereign debt restructuring to date.  This paper proposes a framework for restructuring and discusses the key issues that will arise during the restructuring process.  These issues include the vulnerability of PDVSA assets outside Venezuela to actions by creditors (which affects, most importantly, receivables from petroleum sales and PDVSA’s interest in the U.S.-based CITGO); whether the restructuring should be implemented in one or two steps (an immediate restructuring versus the reprofiling of principal payments in the short term); the incentives and disincentives for would-be holdout creditors to join a restructuring; and the admissibility and treatment of various claims (such as PDVSA bonds that may have been originally issued at prices below their par value and claims against PDVSA for services billed at significant premiums to market prices).

The article is available here.

Mark A. Walker is Managing Director and Head of Sovereign Advisory at Millstein & Co.  Richard J. Cooper is a Senior Partner in the Restructuring Group at Cleary Gottlieb Steen & Hamilton, LLP.  The views expressed in the article are those of the authors only.

Sovereign Debt Restructuring and English Governing Law

By Steven L. Schwarcz (Duke University School of Law)

This Roundtable post is based on the author’s forthcoming article, Sovereign Debt Restructuring and English Governing Law, scheduled for publication in a symposium issue of the Brooklyn Journal of Corporate, Financial and Commercial Law (available at http://ssrn.com/abstract=2952776).

Unsustainable sovereign debt is a serious problem for nations as well as their citizens and creditors. It also is a threat to global financial stability. The existing “collective action clause” contractual approach to restructuring that debt is inadequate. At the same time, a multilateral framework, such as a convention or treaty, is not currently politically feasible. Recent research shows a drastic rise in sovereign debt litigation by holdout creditors, suggesting the urgency of finding solutions.

This article proposes a novel legal framework, focusing on governing law, for restructuring unsustainable sovereign debt. Because a significant percentage of sovereign debt is governed by English law, the UK Parliament has a unique opportunity to modify that law to include the legislative equivalent of perfect aggregate-voting collective action clauses in all English-law governed sovereign debt contracts. That not only would facilitate the fair and equitable restructuring of unsustainable sovereign debt; it also should ensure the continuing legitimacy and attractiveness of English law as the governing law for future sovereign debt contracts.

The article also proposes and examines the text of a model law that Parliament could consider as a basis for its legislation. Additionally, the article explains why, even absent Parliamentary enactment, a model-law approach could contribute to the incremental development of sovereign-debt-restructuring norms.

The full paper is available here

Solving the Pari Passu Puzzle: The Market Still Knows Best

By Sergio J. Galvis (Sullivan & Cromwell LLP)

As a result of the Argentine sovereign debt crisis and ensuing holdout litigation saga, the pari passu (or ranking) clause became a source of great consternation in the international sovereign bond market. Specifically, Judge Griesa’s holding that Argentina had violated the pari passu clause by refusing to pay creditors who had not participated in the nation’s earlier debt exchanges, and the accompanying requirement that Argentina had to pay those holdout bondholders, led to uncertainty in the market regarding the leverage holdouts could exercise in sovereign debt restructurings going forward. Concern was expressed over the ability of sovereigns to succeed with voluntary exchange offers premised on the threat that the restructuring sovereign would default on payments due to non-participating bondholders. This article evaluates the impact of the court’s decision in the Argentine litigation to date, including subsequent court decisions that have helped reinforce the view that the equitable holding in favor of the holdouts in the Argentine saga is a narrowly prescribed outcome that is unlikely to be repeated absent extraordinary circumstances. It then examines the adoption of improved ranking clauses and collective action voting clauses in recent issuances of sovereign debt in the effort to bring greater certainty to market participants and facilitate efficient restructurings in the future without the need for extra-contractual restructuring mechanisms and remedies.

The full article is available here.


For other recent Roundtable posts related to sovereign debt, see Lubben, “Sovereign Bankruptcy Hydraulics“; Gulati and Rasmussen, “Puerto Rico and the Netherworld of Sovereign Debt Restructuring“; and a Cleary Gottlieb update on Puerto Rico’s bankruptcy.

Pari Passu Undone: Game-Changing Decisions for Sovereigns in Distress

By James Michael Blakemore (Cleary Gottlieb Steen & Hamilton LLP)

In “Pari Passu Undone: Game-Changing Decisions for Sovereigns in Distress,” which appears in Issue No. 3 of the “Cleary Gottlieb Emerging Markets Restructuring Journal,” published by Cleary Gottlieb Steen & Hamilton LLP,[1] Michael Lockman and I examine a recent decision in White Hawthorne, LLC v. Republic of Argentina, No. 16 Civ. 1042 (TPG), 2016 WL 7441699 (S.D.N.Y. Dec. 22, 2016), regarding the hotly litigated pari passu clause.

Following an economic catastrophe in the early 2000s, the Republic of Argentina successfully restructured the vast majority of its more than $80 billion of debt, exchanging new bonds for those on which the crisis had forced default. In February 2012, Judge Thomas P. Griesa of the Southern District of New York, based on a boilerplate provision in the defaulted bonds known as the pari passu clause, enjoined Argentina from servicing its restructured debt without simultaneously making ratable payments to holdout creditors who had refused to participate in the exchange. This interpretation was unprecedented and, given the pari passu clause’s ubiquity in sovereign debt instruments, threatened to reverberate far beyond the specific facts of Argentina’s case. For nearly five years, anxious sovereigns and market participants were left to ponder the scope of these rulings. Most basically, would a sovereign debtor’s decision to pay some but not all of its creditors, taken alone, violate the pari passu clause?

Judge Griesa has now answered this crucial question. Following Argentina’s announcement, in February 2016, of a global proposal to settle its defaulted debt, a group of hedge funds brought suit, arguing in part that Argentina’s settlement with other creditors violated the pari passu clause. In White Hawthorne, Judge Griesa disagreed. The Court’s opinion confirmed that, absent aggravating circumstances—Judge Griesa mentioned specifically the “incendiary statements” and “harmful legislation” of Argentina’s former government—a sovereign debtor may pay some of its creditors and not others without running afoul of the pari passu clause. The decision does much to clarify the limits of the pari passu clause and deals a serious blow to creditors who would interpret the clause broadly to undermine future sovereign restructuring efforts.

The full article is available here.


[1] The firm represented the Republic of Argentina in the matters described in the article. The views expressed here are solely those of the authors and do not necessarily reflect those of the firm or its clients.

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