- By Jamila TrindleJamila Trindle is a senior reporter who covers finance, economics and business where they intersect with national security and foreign policy. Her beat spans everything from the economic underpinnings of conflict to sanctions, corruption and terror finance. Before coming to Foreign Policy magazine, Jamila reported for the Wall Street Journal’s Washington bureau, covering financial regulation and economics. She has also worked as a foreign correspondent in China, Indonesia and Turkey as a freelancer for NPR, Marketplace, The Guardian and others. She moved back to the U.S. to cover the post-crisis economy for PBS in 2009.
This story has been updated.
Kazakhstan is the first country to adopt reforms designed to protect governments and investors from the kind of protracted legal fight that culminated in Argentina’s bond default this summer. Whether it sparks a trend — and how much of a difference it makes — remain to be seen.
Kazakhstan issued its first bonds since 2000 on Monday, Oct. 6, and is expected to sell $1 billion worth of them on the international market. The sale is likely to pique the interest of investors seeking opportunities in emerging markets. It is also garnering the attention of industry groups and policymakers clamoring to change bond contracts after a U.S. court blocked payments intended for the majority of Argentina’s creditors in July.
In the event of a looming default, the bonds’ terms force all investors to accept payments lower than their bonds’ face value if a majority of bondholders agree to do so. A minority wishing to hold out for full payment cannot gum up the works, as they did in Argentina’s case.
Argentina spiraled toward default this summer after a multiyear legal battle with hedge funds that bought the country’s bonds on the cheap and demanded payment in full. The fight between President Cristina Fernández de Kirchner’s government and hedge fund NML Capital, a subsidiary of U.S. billionaire Paul Singer’s Elliott Management, climaxed in July when negotiators couldn’t reach a last-minute agreement preventing the country from defaulting for the second time in 13 years. In 2012, a New York court ruled in favor of NML Capital — the hedge fund that pursued Argentina’s assets in court for years — stopping payments to the 93 percent of bondholders who struck a deal with Argentina to accept less than originally promised.
To avoid a similar fate, the Kazakh government incorporated changes to standard bond contracts suggested by an international financial-industry trade group in August. Argentina’s messy default sparked debate and a search for a way to keep the same thing from happening to other countries. The International Capital Market Association encouraged bond-issuing countries to include provisions making it harder for a few investors to hold up negotiations if a country can’t pay its debts. The U.S. Treasury Department supported the association’s reform proposal, and on Monday, the IMF also threw its weight behind the changes.
The recommended provision forces all of a country’s investors to accept a compromise with the debtor country if 75 percent of bondholders vote for it. A second change clarifies a common Latin phrase, pari passu, that became central to the Argentine case.
"This clause does not require ratable payment to all creditors, but, rather, only equal legal ranking," the IMF’s general counsel said in an interview posted on the IMF’s website. "It would only prohibit actions that result in legal subordination of certain unsecured creditors over others."
Anna Gelpern, a debt-contract expert who worked on the International Capital Market Association’s plan, said Kazakhstan’s adoption is only the beginning. It’s a "really good step both as a partial solution and as a message," said Gelpern, who is a law professor at Georgetown University and a senior fellow at the Peterson Institute for International Economics.
Many observers expect other countries to follow suit, but it’s up to each individual government to decide. The new contracts don’t affect existing bonds, meaning those contracts could run into the same legal tango as Argentina’s. Countries could swap those bonds for new ones with the new contract, but the IMF concluded there isn’t interest yet in that route.
The new contractual protections won’t stop defaults entirely. Argentina’s government and its hedge fund nemesis, NML Capital, are both widely considered outliers with greater appetites for high-profile court battles than most bond-market players. No amount of new language can keep another group of investors from going to court or keep another country from walking away from its obligations. When a country decides that it can’t make the payments promised in the bond contract, it has to negotiate with its investors, and there’s no guarantee that all parties will leave happy.
"It’s not easily enforceable; these are promises," said Charles Blitzer, who worked on bond negotiations at the IMF and now consults on them.
Kazakhstan’s bonds are drawing the attention of investors tempted by increasingly exotic securities as the profitably of stable investments decline. The U.S. Federal Reserve’s decision to hold down interest rates since the financial crisis is dampening returns on safer assets, fueling the search for riskier bets that come with promises of higher yields.
The IMF estimates that investments in bonds issued by riskier countries have more than doubled recently. Since 2010, foreign holdings of emerging-market debt have expanded from $400 billion to $1 trillion. "Frontier" market nations — a subset of "emerging" market countries — are even less developed and include the likes of Ecuador, Kazakhstan, and Kenya. Fourteen countries issued bonds for the first time between 2010 and July 2014, for a total of $8.5 billion worth of debt, according to a recent IMF paper. According to a Financial Times tally, frontier-market countries issued more than twice that amount last year — more than $20 billion in total.
All these new bonds have economists worried about what will happen when the Fed starts raising U.S. interest rates next year. The Fed’s policy of keeping domestic interest rates close to zero has made borrowing cheaper for developing countries. Interest rates aren’t expected to start rising until the middle of next year, but some economists think that it could trigger a pullback by investors interested in retreating to safer assets in the United States and other developed countries.
The IMF highlighted this risk Thursday in its latest forecast for global growth. If interest rates rise faster than expected, the reversal of money flows could hit vulnerable emerging markets, IMF economists said. The IMF said global growth wouldn’t meet expectations in 2014, in part because of a slowdown in emerging markets. The IMF reduced its 2014 estimate to 3.3 percent from 3.4 in July and bumped its 2015 forecast to 3.8 from 3.6 percent.
Growth in emerging markets could be even lower next year. “For emerging markets, despite downward revisions to forecasts, the risk remains that the projected increase in growth next year will fail to materialize,” the IMF said in the latest economic outlook, which is produced twice a year. The IMF and World Bank annual meetings start Friday in Washington.
If climbing U.S. rates cause investors to pull out of emerging markets quickly, it could affect local currencies and cause borrowing costs to go up. If that happens, it could make it harder for governments to repay their outstanding debts, which are often denominated in dollars and euros. Gabriel Sterne, head of global macro investor services at Oxford Economics and a former IMF and Bank of England economist, warned recently that historically 24 percent of countries rated as "riskier" investments by credit-rating firms end up defaulting.
But until then, countries will likely race to sell more bonds while they can still borrow on the cheap.