Optimal Collective Action Clause Thresholds

Abstract

Since February 2003 a number of debtor countries have issued bonds with collective action clauses (CACs) under New York law - a development welcomed by the official sector as tangible progress towards more orderly crisis resolution. Not all of these countries, however, have opted for the same CAC voting threshold, raising concerns that lack of standardisation might undermine the wider adoption of CACs. In this paper, debtors' optimal choice of CAC threshold is analysed using a theoretical model of "grey-zone" financial crisis, which allows for the interaction of liquidity problems with solvency problems. It finds that individual countries may wish to set different thresholds because of differing risk preferences and creditworthiness. Strongly risk-averse debtors put much greater weight on pay-offs during crisis periods than during non-crisis periods and are therefore more likely to choose lower CAC thresholds than less risk-averse debtors. The worse the creditworthiness of risk-averse debtors, however, the more likely they will want to issue bonds with high collective action clauses.

Keywords: Sovereign debt, liquidity crises, restructuring mechanisms, collective action clauses

JEL Classification: F33, F34