Creditors to take collective action

By Andrew Walker
Economics correspondent, BBC World Service

Image caption,
Greece's debt problems have led to many protesters taking collective action of a different sort

The euro area already has two bail-outs underway, for the Republic of Ireland and Greece.

The creditors, the bondholders, are being protected. They won't lose money. There will be no "haircuts" for them, in the language of the financial world.

But that could all change for rescues after 2013, when the arrangements hastily put together earlier this year expire.

There will be a new rescue facility for the euro area after that date. The details are pretty sketchy, including the all-important question of how much cash will be available.

But there are some things we do know, including the possibility that creditors will lose money. We have even been told about one important reform that might make those losses a little easier to force down the throats of reluctant creditors.

It is called a "collective action clause", and what it means is that if a large enough majority of creditors vote to accept losses - to have their hair cut - it's binding on other creditors.

Finance ministers from the euro countries agreed last month that, from June 2013, all new borrowing by euro governments will have one of these collective action clauses.

Voting for cuts?

How do they work? If a borrower gets into difficulty, the creditors can be asked to accept a change in the repayments. It might just be a rescheduling, but it might involve real losses, perhaps a lower interest rate, a longer delay or a lower principal payment.

They vote and if enough accept the others then lose their right to sue for full payment. The threshold is generally more than a simple majority. It's often 75%.

That raises the question: why on earth would any creditor vote to have their payments cut? Because if a borrower is in trouble what they, the creditors, are offered might be the best they can get.

An orderly "haircut" might be preferable to a chaotic default, which might be more like having clumps of hair pulled out by the roots. If most creditors take that view then they can prevent a minority from disrupting the process with legal action.

Limiting disruption

Collective action clauses are not new. They were introduced into English law in the 19th Century for company debt. More recently they have become common in developing country government bonds.

What would be new would be having them in all new euro area government debt. At first, there would be a lot of old debt not covered. So the chances of these clauses fixing the current crisis, if it is still rumbling in 2013, aren't great.

Over time, however, that would change and these clauses could help limit the disruption when it becomes clear that a country can no longer pay its debts in full and on time.

And there will be government defaults somewhere at some stage in the future. Not necessarily in the euro area, but the lesson of the last year is it's best to be prepared for the worst.