From the New Year, all newly issued euro zone sovereign debt will include a legal provision that can force investors to accept losses in a crisis. Collective Action Clauses (CACs) were originally intended to give legal clout to investors from the developed world who needed to push through restructuring of the bonds of developing counties’ governments in financial crisis. The euro zone, led by Germany, is the first developed economic bloc to include CACs routinely in its domestic and international bond contracts. As the euro crisis has shown, emerging markets no longer hold a monopoly on the risk of governments going bankrupt or defaulting on their debt.
One lesson of Greece’s sovereign debt crisis was that the absence of CACs made it more difficult for the official orchestrators of the country’s bailout to organize a write-down of privately held bonds to lessen the country’s debt burden and thus debt service. Bond owners, such a hedge and vulture funds, could, and did, hold out against such moves, to their considerable profit. Not that that should have come as a surprise. The same resistance complicated resolving Mexico’s debt crisis in the mid-1990s and Argentina’s in 2001.
It will take perhaps a decade for all outstanding euro zone government debt to be rolled over into new bonds containing CACs. But in future, if two-thirds of holders of euro zone government bonds agree to take a haircut, as the jargon has it, the remaining minority will have no choice but to do the same.