Restructuring Italian (or Other Euro Area) Debt: Do Euro CACs Constrain or Expand the Options?

Abstract

This paper examines the intersection between two fundamental attributes of Euro Area sovereign debt. The first is that sovereigns tend to issue bonds governed by their own law, which makes a debt restructuring comparatively easy. The second is the standardized collective action clause (CAC) mandated for most sovereign bonds by the treaty establishing the European Stability Mechanism. These Euro CACs let a bondholder supermajority approve a debt restructuring in a vote that binds dissenters. How Euro CACs interact with local law advantage is one of the central legal uncertainties affecting debt restructuring in the Euro Area. History teaches that borrower governments can easily restructure local-law debt. But this intuition co-exists with a widespread sense that Euro CACs make it harder for governments to exploit the benefits of local law.

Using a hypothetical Italian debt restructuring as an example, this paper explains why Euro CACs do not, in fact, materially constrain a sovereign’s ability to change its local law to facilitate restructuring. Put simply: From a restructurer’s perspective, Euro CACs are the safe option, not the only one. A restructuring conducted via the CAC will leave no holdouts and will survive almost any legal challenge. But a sovereign that has issued local-law debt remains free to alter its law to facilitate restructuring, although it will encounter various legal constraints in doing so. These constraints, however, are not absolute; there is room for the prudent exercise of local law advantage. The paper closes by discussing implications for current reform efforts in the Euro Area, including efforts to revise the Euro CAC template.

Keywords: Eurozone, collective action clause, European Stability Mechanism, Italian debt, sovereign debt

JEL Classification: H63, H74, H87