RDP 2003-02: Do Collective Action Clauses Influence Bond Yields? New Evidence from Emerging Markets 5. Conclusion

This paper has presented further evidence that the inclusion of CACs has not influenced borrowing costs over the past decade or so. This is consistent with the weight of earlier empirical studies and is not surprising given the evidence cited in Becker, Richards and Thaicharoen (forthcoming) that the market-place has historically paid no attention to this particular aspect of bond contracts. It is also consistent with observations by market participants (e.g., Petas and Rahman (1999) and Dammers (2002)) that the inclusion of CACs has simply not been an important decision variable for borrowers or investors.

However, the paper has also presented new evidence about the pricing of bonds with and without CACs in the secondary market as of 31 January 2003. By comparing the yield on bonds issued in the Euromarket with CACs, and bonds issued in the US market and Euromarket without CACs, we show that the inclusion of CACs in bonds issued in the Euromarket did not impact secondary market yields as of early 2003. This suggests that even after the extensive debate over possible reforms to crisis resolution, financial market participants had still not focused on which bonds had CACs or that they did not believe that the existence or absence of CACs was relevant to the pricing of bonds.

The challenge for greater use of CACs will be to change market convention and have these terms included in new bonds issued into the US market. The fact that the bond market currently prices existing bonds with and without CACs no differently, and that many US investors already hold bonds with CACs – apparently often without being aware of it – suggests that there is no good reason why bonds with CACs cannot be sold into the US market at similar yields to bonds without CACs.

Of course, opponents of CACs might well argue that the use of CACs in all bonds, including in the US market, would represent a regime change and might signal that bond restructurings would become a more frequent phenomena and that investors will lose from this. However, the historical record provides little to suggest that emerging markets would rush to restructure in the event that there were reforms to make restructuring somewhat smoother. Indeed, recent crises suggest that elected officials and policy-makers in emerging markets are too slow rather than too eager to deal with incipient debt-servicing problems. The result of their delay in approaching their creditors is invariably to make losses for creditors far larger than they need be. One can therefore make a strong case that investors will benefit from well-targeted reforms – either the SDRM or greater use of CACs – that make it more likely that debt-servicing problems are addressed before they develop into full-blown crises.

Indeed, the successful placement by Mexico of bonds with CACs into the US market on 26 February 2003 – which occurred after the results in this paper had been finalised – suggests that US investors have come to realise that the use of well-designed CACs is not inconsistent with protection of creditor rights. The placement of US$1 billion of bonds due in 2015 occurred at a yield that was almost exactly in line with Mexico's 2013 and 2016 issues, which do not contain CACs. Following the issue a senior Mexican official was quoted as saying that ‘Now everyone understands that if properly designed, [CACs] represent a benefit both for the issuers and the holders, so there is no reason for a premium to be paid’.^[19]

Footnote

See ‘Mexico Sells $1 Bln of Bonds With Default Clauses’, Bloomberg L.P., 26 February 2003. [19]