The Evolution of Eurozone Debt Contracts Frank Smets & Mitu - PowerPoint PPT Presentation

The Evolution of Eurozone Debt Contracts Frank Smets & Mitu Gulati The views expressed are our own and not necessarily those of the European Central Bank or its Governing Council.

Question • How have international debt contract terms evolved in euro area countries over the past three decades (and after EMU in particular)? – First step towards analyzing whether yields of sovereign bonds with different contract terms have responded differently to recent news.

Motivation • From an empirical point of view: – There is a lot variation in euro area contract terms, which will allow us to empirically investigate the implications. • From a theoretical point of view: – Entry of EMU is a bit like a natural experiment – Can help distinguish between theories of why countries choose to issue under certain contract terms • From a policy perspective: – EU Heads of State have decided that as of 2013 all euro area contracts will include Collective Action Clauses.

Contract terms • Maturity • Currency • Collateral (e.g negative pledge) • Collective Action Clauses • Listing • Governing Law • Sovereign Immunity

Theory 1 Commitment versus flexibility (“tying your hands”) • Contract terms determine how easy/difficult it is to restructure one’s debt in the event of a big negative shock; (also whether a country can inflate the debt away; whether creditors can “punish” bad behaviour). • Weak countries that can not credibly commit to overborrow will have an incentive to tie their hands and go for less “flexible” contract terms. • This is a typical story – stronger firms are able to negotiate more flexible terms (terms that make restructurings easier)

Theory 2 • The historic logic behind mandating CAC proposals after Mexican bailout in 1995: – Reduce the need for/size of bailouts • Mandatory contract terms are generally inefficient unless there are externalities (contagion fears): – Nations agree to terms that make restructurings slow, difficult and expensive; – Because it increases the probability of others to provide bailouts

Impact of entering EMU • Entering EMU means being fiscally responsible (SGP) and subscribing to no-bail-out (credibility bonus): – Predicts a shift towards more flexible contract terms. • Euro area is an economic and monetary union where nations are interconnected; (high externalities): – Predicts a shift towards contract terms making restructurings more difficult (and bailouts more likely)

Data • 30 years of sovereign debt contracts • Two sources – Dealogic & Thomson Financial • 400 plus contracts for six Eurozone periphery countries: Belgium, Greece, Ireland, Italy, Portugal, Spain (also looking at Austria and Finland) • We coded terms for Credibility & Restructuring

Figure 9B. Changes in Listing in Non-Euro Nations (1980 - May 2011) 618 700 288 600 94 80% 500 400 Total 300 58% 31% Lux 200 100 0% 10% New York 0% 0 New York Lux Total

Figure 9A. Changes in Listing in Eurozone Periphery (1980 - May 2011) 178 172 180 60 160 140 65% 120 55% 100 Total 80 30% 60 Lux 40 30% 3% 5% 20 Local 0 Local Lux Total

Data Slides

Figure 1B. Changes in Negative Pledge in Non-Euro Nations (1980 - May 2011) 618 700 600 288 500 94 400 76% 300 Total 200 69% 49% 100 Negative Pledge 0 Negative Pledge Total

Figure 1A. Changes in Negative Pledge in Eurozone Periphery (1980 - May 2011) 178 172 180 160 60 140 85% 120 100 60% 80 Total 60 72% 40 Negative Pledge 20 0 Negative Pledge Total

Figure 7B. Changes in Governing Law in Non-Euro Nations (1980 - May 2011) 618 288 700 94 600 Total 39% 500 38% 33% 400 English 300 6% 2% 1% Local 200 53% 35% 100 New York 19% 0 New York Local English Total

Figure 7A. Changes in Governing Law in Eurozone Periphery (1980 - May 2011) 178 172 60 180 160 140 41% Total 37% 120 26% 100 44% English 80 21% 0% 60 Local 40 27% 20 0% 10% New York 0 New York Local English Total

Conclusions • Upon EMU entry, nations enjoyed (a) more credibility and (b) more flexibility in ability to manage debt stock. • In other words, there was a belief that there would be no bailout (Maastricht Treaty)

Figure 2A. Changes in IMF in Eurozone Periphery (1980 - May 2011) 178 172 180 160 60 140 120 100 80 Total 60 40 32% 16% 1% IMF 20 0 IMF Total

Figure 2B. Changes in IMF in Non-Euro Nations (1980 - May 2011) 618 700 288 600 500 94 400 300 Total 36% 200 23% 1% 100 IMF 0 IMF Total

Figure 3A. Changes in Disenfranchise in Eurozone Periphery (1980 - May 2011) 178 172 180 160 60 140 120 100 80 Total 60 20% 40 0% Disenfranchise 6% 20 0 Disenfranchise Total

Figure 3B. Changes in Disenfranchise in Non-Euro Nations (1980 - May 2011) 618 700 600 288 500 400 94 300 36% Total 200 100 Disenfranchi 0% 2% se 0 Disenfranchise Total

Figure 4A. Changes in Sovereign Immunity in Eurozone Periphery (1980 - May 2011) 178 172 180 160 60 140 77% 120 100 73% 80 Total 60 77% 40 Sovereign Immunity 20 0 Sovereign Immunity Total

Figure 4B. Changes in Sovereign Immunity in Non-Euro Nations (1980 - May 2011) 618 700 288 600 500 86% 94 400 300 Total 200 78% 100 71% Sovereign Immunity 0 Sovereign Immunity Total

Figure 5A. Changes in Currency in Eurozone Periphery (1980 - May 2011) 172 178 180 160 60 140 120 38% 100 80 Total 28% 53% 60 28% Dollar 40 10% 20 Euro 0% 0 Euro Dollar Total

Figure 5B. Changes in Currency in Non-Euro Nations (1980 - May 2011) 618 700 288 600 500 70% 94 400 Total 300 54% 53% 200 Dollar 23% 100 5% 0% Euro 0 Euro Dollar Total

Figure 6A. Changes in Acceleration in Eurozone Periphery (1980 - May 2011) 178 172 60 180 82% 160 140 48% 120 Total 100 65% Individual 80 28% 60 0% 0.25 0% 40 14% 21% 20 28% None 0 None 0.25 Individual Total

Figure 6B. Changes in Acceleration in in Non-Euro Nations (1980 - May 2011) 618 288 700 600 94 500 31% Total 400 40% 43% 52% Individual 300 16% 200 0% 0.25 100 32% 13% None 50% 0 None 0.25 Individual Total

Figure 8A. Changes in Jurisdicion in Eurozone Periphery (1980 - May 2011) 172 178 60 180 160 42% 140 Total 120 21% 100 2% Local 80 32% 26% 20% 60 English 40 20% 25% 20 New York 23% 0 New York English Local Total

Figure 8B. Changes in Jurisdicion in Non-Euro Nations (1980 - May 2011) 618 288 700 600 94 500 37% 400 Total 300 26% 22% English 200 46% 43% 100 New York 32% 0 New York English Total

Figure 10A. Changes in Min Mod Vote in Eurozone Periphery (1980 - May 2011) 178 172 60 180 62% 160 59% 140 Total 120 63% 100 1 80 18% 0% 0% 60 .67 or .75 20% 41% 40 37% 20 Under .40 0 Under .40 .67 or .75 1 Total

Figure 10B. Changes in Min Mod Vote in Non-Euro Nations (1980 - May 2011) 618 288 700 94 600 40% Total 500 61% 400 69% 1 41% 300 2% 1% .67 or .75 200 38% 19% 100 29% Under .40 0 Under .40 .67 or .75 1 Total

Figure 11A. Changes in Maturity in Eurozone Periphery (1980 - May 2011) 173 167 60 180 160 140 Total 33% 120 32% 47% 11% 11 or more 100 years 80 23% 62% 60 6-10 years 44% 43% 40 7% 20 0-5 years 0 0-5 years 6-10 years 11 or more years Total

Figure 11B. Changes in Maturity in Non-Euro Nations (1980 - May 2011) 587 280 94 600 500 Total 32% 400 41% 11% 11 or more 39% 300 years 55% 44% 200 6-10 years 29% 3% 100 45% 0-5 years 0 0-5 years 6-10 years 11 or more years Total