The government agreed last night to extend the deadline for its consent solicitation and exchange offer by one day to Monday 3 August, according to Bloomberg, following legal action by some bondholders who are part of the Steering Committee. The extension came at the request of a US court to allow it more time to review the case. The exchange offer, which was launched on 20 July, was due to close today (31 July, 5pm CET).
The plaintiffs argue the exchange is coercive and based on false and misleading information, and seek injunctive relief, according to court filings (available via Bloomberg). A hearing is set for 2.30pm NY time today, in order for the judge to hear more legal arguments, according to Bloomberg. The lawsuit was filed in the US District Court Southern District of New York on Wednesday (29 July). The presiding judge is Judge Valerie Caproni.
Background to the offer
The terms of Ecuador’s exchange offer are the same as those set out on 6 July in the Agreement in Principle (AIP) with a group of major bondholders (the Ad Hoc Group). The Ad Hoc group held c45% of the debt in aggregate. There was no modification to the offer to reflect the counter-proposal published on 13 July by a second group of bondholders (the Steering Committee) who held more than 25-35% of certain bonds across the maturity spectrum – and thereby conferring a potential blocking stake in some circumstances under the bonds' collective action clauses (CACs). The offer was subsequently launched fairly speedily on 20 July and with a tight timetable of just two weeks. The Steering Committee issued a statement on 20 July quickly rejecting the terms of the offer.
The government has stated it has strong support for its offer. It noted on 21 July that the Ad Hoc Group had increased its support to more than 53%, with over or close to 50% in almost every individual series. Together with informal support beyond the Ad Hoc Group, it noted support had reached near 60%, in touching distance of the relevant voting thresholds for most of the bonds – for all eligible bonds excluding the 24s, that is a) more than 50% of each bond and b) more than 66.67% in aggregate, and more than 75% for the 24s for reserved matter modifications. The government has also set a minimum participation threshold of 80%.
From good faith to bad precedent?
While the process of Ecuador’s restructuring has shown elements of good faith, from the approach to the initial consent solicitation exercise in April through to the AIP reached in July (and we have applauded it ourselves – see our note on 7 July; indeed, it may have been a textbook model), there are some features that may be more troublesome to investors and that could set a precedent for future sovereign debt restructurings, and which we think only came to light in the invitation memorandum when the offer was launched. These mainly pertain to the treatment of non-tendering holders, and seem to go beyond what we have come to expect from the typical-use exit consents that seek to diminish the rights and value of bonds that get left behind.
We highlight two main areas of concern for investors:
First, unlike in previous restructurings, although non-tendering holders (holdouts) can be expected to be crammed down (dragged along) if required participation thresholds are met, here, such holders will not receive the same package as everyone else. Instead, they only receive the new 2040 bonds, the longest dated and, most likely, least liquid bond. Nor will they receive the PDI bond by way of payment for past due interest. Hence, those that don’t tender risk suffering a financial loss and, in our view, appear to be discriminated against. This loss in value might be worth c11 pts (including interest) or c9pts (excluding interest), according to the plaintiffs. It is in this sense, in part, that the plaintiffs argue the offer is coercive.
We are not aware of another sovereign restructuring in which those that were crammed down through the use of CACs were treated less favourably than the rest. Granted, sovereign debt restructurings that have taken place with CACs are a fairly recent phenomenon, and many of those that have been undertaken have had only a small number of bonds (or just one). Ecuador’s treatment of non-tendering holders could set a precedent for other restructurings, especially those countries looking to restructure bigger bond stocks.
Second, redesignation and further restructuring offers. The exchange offer is explicit in warning that the authorities retain the right to redesignate one or more series of bonds to allow their exclusion from the calculation of the requisite consents on an aggregate basis for the proposed modifications and to calculate the requisite consents on a single series for those bonds that have been excluded. Redesignation was first mooted in Argentina’s concurrent exchange – to the displeasure of most investors – although Ecuador might beat it to it. The effect, we think, is two-fold. By excluding certain bonds, it makes it easier to achieve the thresholds on the other bonds and, by carving out the bonds it doesn’t include, it can either leave them as a rump with weaker rights (and not being paid) or force those holders into weaker instruments (ie eligible bonds held by non-consenting holders will be modified to reflect the economic terms of the new 2040 bond). The exchange also allows for further restructuring offers (“restructuring exchange offer”) to eliminate holdouts from the first round, a solution to Argentina’s Pac-Man strategy.
While Ecuador may have also imposed some constraints on how it can use redesignation and further restructuring offers (compared with Argentina) – see Buchheit and Gulati’s recent paper – The Argentine Collective Action Clause Controversy – the emergence of these legal remedies to deal with a potential holdout problem as a factor in sovereign debt restructurings is new and uncharted territory. It's not clear to us, when ICMA's model aggregation clause arrived in bond documentation in 2014, that it was envisaged that issuers could then change the voting pool to manipulate the results to get the answers it wants. Instead, we think the emphasis should remain on good-faith negotiations, information exchange, transparency and engagement with as broad a base of creditors as possible, in accordance with best practice as set out in the IIF Principles for Sovereign Debt Restructuring.