Jun 12, 2023 - Economy

Ambitious N.Y. bill takes aim at global debt woes

Illustration of the earth with a spotlight in the shape of New York state shining on it.

Illustration: Brendan Lynch/Axios

A bill quietly making its way through the New York state legislature could upend the world of sovereign debt investing.

Why it matters: There’s a debt crisis brewing among lower-income nations, and creditor gridlock is prolonging the pain for countries like Zambia and Sri Lanka that need to restructure their unsustainable debt loads.

Enter New York: About half of sovereign bonds are governed by New York law — so Albany (the capital of New York state) wields outsize influence on the global lending landscape.

  • A group of state legislators has proposed a short bill with tall ambitions — but critics charge there’s a host of unintended consequences that'll make things worse for those the bill is meant to help.

So what's in the bill? It would require private sector creditors holding New York-law bonds (think banks, asset managers and hedge funds) to accept the same losses on their holdings that “official sector” creditors (i.e. governments, like the U.S. or U.K.) agree to take in a restructuring.

To understand what that means, some background:

  • There's no bankruptcy regime for sovereigns. Therefore, when a country’s debt reaches unsustainable levels, the only option for relief is to undergo what's known as a debt restructuring process.
  • That entails negotiations with creditors about reducing the amount of money that will ultimately be paid back. It's a deeply complex process involving private and public sector creditors from all over the world — all with different motivations and fiduciary duties.

In a nutshell: The bill aims to simplify that process, by imposing a cramdown on all New York-law creditors.

  • That would put an end to “the U.S. government bailing out the private sector,” says Eric LeCompte of Jubilee USA, a nonprofit that advocates for debt relief for developing countries. He’s referring to the fact that private creditors, on average, recover an estimated 20 cents on the dollar more than official sector creditors in sovereign restructurings.
  • It would also weaken the hand of “predatory vulture funds” that buy the debt at a discount and demand outsized payouts, he says.

Where it stands: The bill didn’t make it to the floor in New York's most recent legislative session, which ended last week; it's expected to be back on the agenda next year.

But, but, but: Not surprisingly, private sector investors have come out against the bill, since it would bind them to deals struck by the “Paris Club” of government creditors — who often, understandably, have broader political motivations for debt forgiveness.

  • Even the International Monetary Fund — whose board notably consists largely of Paris Club creditor countries — implied last week that it's not a fan of the New York bill.
  • The elephant in the room: The bill does little to compel the largest holdout creditor in today's sovereign restructurings — China — to the negotiating table since China's loans aren't bound by New York law.

Context: Many market participants who oppose the bill are broadly aligned with the overarching mission to improve the speed and efficiency of the restructuring process, says one such sovereign debt investor who spoke with Axios.

  • They say that the global lending community has been working on this issue for years — and has made progress — and that legislators in Albany are disconnected from the actual borrowers and lenders that the bill would impact.

Go deeper: The most visible sign of market-based progress in recent years is an "enhanced collective action clause" (CAC), a rule in bond documentation that binds all creditors to any deal agreed to by a supermajority of creditors. This makes it easier to get to a deal, and also removes the power of holdouts.

  • Enhanced CACs took hold around 2014, and now nearly all sovereign bonds have them.
  • After enhanced CACs were introduced, the average duration of a sovereign debt restructuring declined to 1.2 years, from 3.5. In the last few years, restructuring deals for Ecuador, Argentina and Ukraine were completed without holdout litigation.

Talks behind closed doors are inching ahead as well, sources note.

  • The Paris Club is set to convene with a group of banks and bondholders next week to discuss the issue of comparable treatment across creditor groups, two sources familiar with the meeting told Axios.
  • The Global Sovereign Debt Roundtable, which kicked off this year and whose goal is to identify and work out kinks in the process, is also meeting this month.
  • "We've been working on this issue for decades. To think Albany is going to fix it in a few paragraphs is the height of hubris," the investor says.

Meanwhile, opponents of the bill say the unwanted side effects boil down to this: It would impede a well-functioning market in which capital is available for borrowers who need it.

  • Lenders will either charge more or withhold funds entirely if they view the risk they're taking as higher — with the most punishing impact on the most vulnerable countries.
  • Borrowers could look for lower-cost debt in other jurisdictions, leading to lost business activity and tax revenue for New York. (The U.K. is the other major jurisdiction for sovereign bond issuance; its Parliament was considering undertaking a similar legislative effort to New York's — but announced last week it wouldn't move forward with it.)
  • Rather than bringing simplicity, enforcement of the bill — which is vague on details — will be litigated for years in New York courthouses.

For its part, the IMF's view is that "well-designed" legislation could be useful if it met certain requirements — but "there are questions as to whether the draft New York law meets" them, according to a spokesperson.

  • Among those requirements: It would need to address "any potential negative impacts on the cost and the access to financing for sovereign borrowers," as well as how the "the functioning of the capital markets" could be impacted by an erosion of creditor rights.

What's next: With a potential vote kicked to next year, New York Sen. Brad Hoylman-Sigal, the bill's sponsor, now says he aims to hold a public hearing on the issue.

Go deeper