File under: Argentina’s battle with its holdouts and the effects thereof on pari passu clauses in sovereign bond contracts elsewhere in the world — with a special crossover to the changing legal status of official lenders in the eurozone crisis.
Spot the difference edition.
The Securities are the direct, unconditional and general and (subject to the provisions below) unsecured obligations of Italy and will rank equally with all other evidences of indebtedness issued in accordance with the Fiscal Agency Agreement and with all other unsecured and unsubordinated general obligations of Italy for money borrowed. Italy hereby pledges its full faith and credit for the due and punctual payment of the Securities and for the due and timely performance of all obligations of Italy with respect thereto. Amounts payable in respect of principal of (and interest on) the Securities will be charged upon and be payable out of the [Treasury of Italy], equally and ratably with all other amounts so charged and amounts payable in respect of all other general loan obligations of Italy.
The Securities are the direct, unconditional and general and (subject to the provisions below) unsecured obligations of Italy and will rank equally with all other evidences of indebtedness issued in accordance with the Fiscal Agency Agreement and with all other unsecured and unsubordinated general obligations of Italy for money borrowed, except for such obligations as may be preferred by mandatory provisions of international treaties and similar obligations to which Italy is a party. Italy hereby pledges its full faith and credit for the due and punctual payment of the Securities and for the due and timely performance of all obligations of Italy with respect thereto.
A big hat-tip to Anna Gelpern at Credit Slips for the spot.
Those are parts of two fiscal agency agreements by the Italian government, made for selling its bonds abroad and for giving directions on how the holders of this debt can expect to be paid. As is de rigueur that means toting a pari passu clause.
The bold parts help you out a bit since this stuff is dry as dust to read. The omission (& addition) between the two is critical, however.
Italy has ditched a promise of ratable payment to bondholders.
Which is interesting. It was a bit weird for this promise to slip into one of the world’s biggest issuers of sovereign debt in the first place. Whiffs of ratable payment have also become a ‘KICK ME’ sign of late to people who sue sovereigns.
OK, so the first excerpt above was drafted in 2003. It includes an unusually direct provision to pay bonds “equably and ratably”, both with each other and with all of Italy’s debt. Italy hasn’t sold very many international bonds as a portion of its debt ever since it joined the euro, so you could argue it doesn’t matter either way.
Then again the whole point of being entitled to ratable payment is that you get to wag the dog on the rest of the debt. If Italy restructured all its local-law bonds but couldn’t cram down holdouts in the foreign-law paper (Cyprus showshow hard it is), then the latter could arguably force payment alongside the restructured, if Italy ever opted just not to pay.
So, in a way taking out ratable payment is crisis insurance for Italy. It might also mean holders of the existing ratably-paid debt have lucked out on legal protection, compared to future buyers of new issues: Italy can’t go back and magick away the old contract.
More to the point, it’s the same concept that has stalked Argentina’s pari passu saga.
As a buzzword, ratable payment broadly means everyone getting paid proportionately what they are owed, though Argentina’s most recent activity in the case has been to argue over what that means in detail. US courts decided that Argentina’s big honking breach of a pari passu clause in some of its defaulted bonds required a ratable payment to holdouts alongside restructured holders.
Technically this was done as the best remedy for Argentina’s flakiness, rather than as an actual interpretation of what pari passu ‘really’ means (more on that in a bit). But in any case ratable payment was shot into the limelight.
Anyway, back to Italy’s promise. It was weird because sovereign debtors generally don’t ‘do’ ratable payment. Or apparently they don’t. It could limit their room for manoeuvre when they struggle to pay their debts, for example. Even so, Italy seemed to tell a more complicated story.
And now the circle has turned again, with the death the “equally and ratably” language — in the second excerpt, dated January 2013, ie well after the implications of NML v Argentina became clear.
1) So, sovereigns do actually change their pari passu clauses? There had been some doubt about this…
Was Italy reacting to Argentina? Did they not like it when we dug up their ratable language recently? Were their lawyers merely doing some contractual hoovering up when it came time to do another fiscal agency agreement?
Whatever the case, it might have been easy to make the change without most creditors of Italy ever noticing. It is still not normal to pore over the contract of a G8 sovereign bond before buying it, eurozone crisis or not. Few seem to be doing it even for sovereigns who are issuing abroad for the first time, to be honest. There’s yield to be chased.
Even so, Italy’s direct chopping of its language follows Belize’s insistence in its recent restructuring that it didn’t consider itself bound to pay the new bonds ratably.
This leads us to the next question…
2) Does Italy’s switch say anything at all about what pari passu ‘really’ means? Pari passu in sovereign debt is a) old and b) mysterious. So there’s much fun to be had in finding the ‘first’ pari passu clause in a sovereign bond and working out why it got there, including whether ratable payment came out of the primordial soup attached to pari passu. It’s the Indiana Jones approach to bond contract law.
Unfortunately it doesn’t quite work for NML v Argentina. Crafting ratable payment as a remedy allowed the Second Circuit to steer right past whether the concept is also to be inferred as the ‘default’ setting for the pari passu clause — whether hallowed by history, found inside a Dan Brown novel, or whatever. The Argentine contract at issue did not restrict the available remedies to bondholders in a court. And judges were simply also bound to look at how Argentina’s holdouts had been uniquely, ostentatiously subordinated over the years.
But in any case, looking forward to the future of sovereign debt, surely Italy’s change tells us that you really can’t infer ratable payment in general. Italy could spell out a promise to pay ratably at one time, and another time it could not spell out this promise. The two times considered together mean ratable payment couldn’t be inferred at all times.
3) So what does that part about “mandatory provisions of international treaties and similar obligations” mean?
This is the addition Italy has made to the second version. Arguably it’s much more important than pari passu word games. (Sorry to say that 1000 words into the post.)
You do sometimes see redolent language in international bond contracts, usually with “mandatory provisions of applicable law” modifying a pari passu clause. But not often treaty law.
As Anna writes, it sounds like a reference to the ESM treaty. There are not many other treaties Italy has agreed to lately which might affect the ranking of its debt. ESM loans apparently get this ranking in a sovereign’s creditors:
Heads of State or Government have stated that the ESM loans will enjoy preferred creditor status in a similar fashion to those of the IMF…
Which is not very clear. The IMF itself is senior, but it’s not really really senior until a restructuring actually happens and preferential payments come on the agenda as the sovereign dishes out recovery amounts to creditors. It’s all implicit. The ESM’s status is also apparently negotiable bailout by bailout.
Also, nota bene: Italy hasn’t borrowed from the ESM so far and might never borrow from it. But if Italy still has to warn international bondholders that they might face subordination from now on, isn’t ESM loan seniority more explicit already?