Amending payment terms in loans to sovereign borrowers – should we allow the majority to decide?

In-depth analysis

"Why should he, then, protect our sovereign, He being of age to govern of himself…"

Background

In November 2022, the Loan Market Association (LMA) released new specimen clauses and guidance for use in commercial loan agreements with sovereign borrowers. Among other points, the clauses provide for the inclusion of majority voting provisions (MVPs) in relation to payment term amendments, with the aim of facilitating the restructuring of such debt. The practice in international sovereign bonds governed by English and New York law has been to provide for a qualified majority vote for amendments to payment terms, but prior to this LMA initiative, equivalent provisions have not typically been incorporated into debt contracts in the form of loans, both syndicated and bilateral.

The timing is prescient: the UK's borrowing requirements grow ever steeper and a short-lived government's mini budget proposals led to chaos in the gilt market. As recession looms alongside vast interest costs from past borrowing, the UK's Debt Management Office will need to sell ever more sovereign debt to balance the books.

The global context is also daunting, as more and more sovereign nations face the spectre of defaulting or restructuring their debts: Ghana, Zambia, Sri Lanka, and Ecuador are recent examples. It therefore seems more appropriate than ever to revisit the terms on which sovereign debt is issued and managed.

"Gap" in the architecture of international sovereign debt

Several prominent and diverse working groups, including the IMF, the LMA, HM Treasury, and a 'Loan Expert Group' comprising members of the Institute of International Finance, investigated this area and arrived at a number of conclusions. One such conclusion is that there exists a "gap" in international sovereign debt architecture which risks creating an imbalance between the rights of private creditors under loan agreements and such rights under bonds.

The 'key deliverable' is a revamp of the voting provisions in sovereign loan agreements to provide for a majority voting threshold in relation to amendment to payment terms, which would aim to facilitate the rescheduling of payments in certain situations including financial distress, and to minimise undue delays and risk to holdout creditors. Such provisions would of course be subject to any applicable international legal framework or treaty governing the restructuring of sovereign debt.

The various working groups clearly consider this corner of the lending market to be in need of pragmatic adjustment. The proposals are, in a sense, an attempt at 'democratising' sovereign debt and moving away from a position where the few can govern the many, or, at least, prevent change where others seek it.

Typical consent provisions in sovereign loan agreements

Typically, sovereign loan agreements have required unanimous lender consent for certain categories of proposed amendments or waivers. Most notably, any amendments to the payment terms of the facility would need the agreement of all lender parties in order to proceed. Therein lies a departure from the established position elsewhere in the sovereign debt markets (eg bonds) where the generally settled position is that majority lender consent is sufficient. The intention – from a policy perspective – is to align the positions across the sovereign debt market and allow the same degree of flexibility to lenders under loan agreements as is currently afforded to bondholders.

Publication of specimen drafting by the LMA

In response to the recognised need for adjustment in this area, the LMA has published specimen clauses for agreements governed by English law, which are drafted to work with LMA documentation, and may be included where suitable for a particular transaction.

The suggested drafting removes "payment term amendments" from the collection of matters typically requiring the consent of all lenders. This prevents a single lender or small group of lenders from preventing a proposed debt restructure by declining to consent to the relevant amendments. By encouraging a consent regime which is more pragmatic, there should be more chance of proactive resolution when (for example) restructuring borrower debt in the case of borrower distress. It should be noted that the recommended voting threshold (75% by value measured by reference to principal) is higher than the typical majority lender threshold, and participations of lenders closely connected with the sovereign borrower are disenfranchised.

Further, the proposed approach extends beyond facility agreements. The debt may, for example, be supported by a guarantee from a governmental or sovereign body, in which case any corresponding changes to payment terms in the facility agreement would also need to be reflected in the guarantee itself, with the drafting dependent on whether the guarantee is included in the relevant facility or standalone.

Concluding thoughts

As noted frequently by commentators in recent times, the growing weight of sovereign debt is resulting in burdensome long term repayment obligations, and a higher level of concern from lenders about the processes for restructuring syndicated sovereign debt should it become distressed. As recent events have demonstrated, an economic spanner in the machinery of monetary policy can have deep repercussions for gilt pricing and associated sovereign debt risks. When even the World Bank talks of a "coming spate of debt crises" (Are we ready for the coming spate of debt crises?) the time would certainly appear ripe to address drafting mechanics in order to incentivise a pragmatic approach by creditors.