Pakistan's deeply funky ties

Pakistan’s deeply funky ties

Mark and Mitu teach courses on sovereign debt at the universities of North Carolina and Virginia respectively, and host the podcast Clauses and controversies. They would also like to thank Leah Berger, Heream Yang and Rishabh Sharma for their research.

Pakistan is heavily indebted. He was already struggling due to Covid spending and political mismanagement. But the recent floods have made matters much worse. Debt restructuring is therefore likely, even imperative (despite protests from government officials).

Some relief has come in the form of IMF and AfDB funding, but, as the market recognizes, this additional debt only makes the hole that Pakistan will have to dig itself out even bigger. Pakistan’s credit rating is in poor shape and its bonds are trading at significant discounts to face value.

We’ve looked at the fine print of Pakistan’s foreign currency bonds. Initially, we were interested in sukuk bonds, as we have never seen a restructured sovereign sukuk. But we came across a plain vanilla sovereign bond that looks anything but vanilla to us.

Pakistan’s 2024 dollar bond – issued in 2014 – has at least two odd features that could pose problems during a restructuring.

The first strange aspect of the bond involves the vote required to pass an extraordinary resolution (for example, to change the issuer’s payment obligations).

Prior to 2003, sovereign bonds often had onerous voting requirements to change payment terms, often requiring unanimous creditor approval. Beginning in 2003, the market moved to allow payment terms to be changed by a vote of 75% of each series of bonds. Then, in 2014, the market changed again to allow the issuer to hold a restructuring vote on multiple series of bonds, with approval requiring an affirmative vote of 66.67% of the entire group, plus 50% of each series concerned. All of these changes were aimed at facilitating restructuring and minimizing the threat posed by holdouts.

Pakistan’s bond in 2024 seems to reveal a total unawareness of all these developments in the market at large.

It defines the extraordinary resolution as “a resolution duly adopted by at least 90% of the votes cast”. Ninety percent? In 2014, when this bond was issued, the broader market was moving to ease the restructuring, and there was no indication that issuers suffered a price penalty for using a lower voting threshold. So why issue what must be one of the friendliest sovereign bonds around?

It is a billion dollar bond that is trading at a steep discount. It won’t take much to buy a position large enough to block a restructuring of this stock. There is a smaller bond, with a face value of $300 million due in 2036, which also appears to have a 90% voting threshold (although the offering circulars are not quite identical).

But that’s not the end of the weirdness.

The offering circular for the 2024 bond is supposed to reprint the actual text of the underlying agency agreement (which we haven’t seen). It defines an extraordinary resolution as “a resolution duly passed by at least 90% of the votes cast”. All of the other sovereign bonds we have seen define the voting threshold as a proportion of the “aggregate principal amount” of outstanding notes.

Makes sense. Someone with $100 million in bonds should count more, for voting purposes, than someone with $1,000. But the 2024 bond simply refers to “votes cast.” So does the investor with a stake of $1,000 matter as much as the investor with $100 million? Oddly, the offering circular for the 2036 bond we mentioned earlier doesn’t have that “votes cast” language. It may be in the agency agreement, which we don’t have.

If a restructuring requires the support of 90% of the votes cast, it introduces even more uncertainty into a restructuring. In theory, a group of investors with small holdings could block a restructuring, even if Pakistan has a group of big bondholders in its corner. This is a risk that most sovereign restructuring companies do not have to take into account.

One can also imagine circumstances in which the language of “votes cast” works to the detriment of a large potential reserve (for example, when more than 90% of the votes cast support the restructuring even if the yes votes represent only a small portion of outstanding debt). This uncertainty benefits no one.

At first, we assumed that the “votes cast” language was a typo. Literally two sentences above that language, in a provision describing the procedures for electronic or written consent to a restructuring, the offering circular explains that the consent is “90% of the aggregate principal amount of the Notes.” . . shall take effect as if it were an extraordinary resolution”.

Surely, we thought, the method of counting the votes would be identical in all these contexts. A friend of ours, a veteran of this trade, tells us that may not be the case. Apparently, a long time ago, for issues held by just a few bondholders who would all show up to in-person meetings, the deals would allow voting That is by a show of hands or by a vote depending on the total amount of the principal assets. Voting was presumed to take place by a show of hands, unless the chairman of the meeting or a 5% holder requested a “poll”. And in the poll, $1,000 would represent one vote.

We don’t have the agency agreement to see if it contains this antiquated definition of “votes cast.” The Offering Circular does not capitalize “votes cast”, which implies that this is not a defined term. The offering circular also purports to reprint “the text of the terms and conditions of the 2024 Notes,” so one would assume that it includes all of the important terms an investor would need to be aware of.

However, the bonds are issued “subject” to the agency agreement, so there may be additional details to clarify the voting process. Whether these provisions should bind investors who never had access to the agency agreement is a separate legal box of worms.

Somehow, we don’t envy the lawyers who may have to figure out how to restructure the 2024 bond. And the 2036 bond doesn’t seem much easier.

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