ANTICIPATING VENEZUELA’S DEBT CRISIS: HIDDEN HOLDOUTS AND THE PROBLEM OF PRICING COLLECTIVE ACTION CLAUSES

A creditor who asks for stronger enforcement rights upon its debtor’s default will rationally accept a lower interest rate reflecting the greater expected recovery the exercise of those rights provides. Over a dozen studies, however, have failed to document this basic relationship in the context of the collective action clause, a key provision in sovereign bonds. We conjecture that this failure is because enforcing the rights in question requires collective decision-making among anonymous creditors with different interests, impeding market predictions regarding future price effects. The pricing of rights that require collective enforcement thus turns on whether the market observes an activist creditor willing to serve as a collectivizing agent to enforce the relevant rights in litigation. When activist creditors, intent on litigating, hide from the market in order to enhance their returns, the market lacks the information to price the collective rights accurately. In this Article, we use data from Venezuela’s ongoing debt crisis to test this collective action story. Our data provides evidence of the absence of price differences in contract terms that require collective decision-making for enforcement. Conversely, we find that in those situations where the market identifies the presence of an activist creditor, the relevant rights do get priced. This evidence sheds light on how the absence of efficient pricing of terms in these collective markets can impede efforts by defaulting sovereign debtors, like Venezuela, to restructure their obligations. Moreover, the timing of when such terms are priced is critical for social welfare. Because collective action clauses that provide strong enforcement rights are not priced at the time the sovereign issues bonds, sovereigns are not given the right incentives to adopt these terms at the outset.  Alfred McCormack Professor of Law, Columbia University.  Murray and Kathleen Bring Professor of Law, New York University.  Professor of Law, Duke University. For comments, thanks to Lee Buchheit, Anna Gelpern, Simon Hinrichsen, Kose John, Josh Mitts, Dominik Nagly, Mark Weidemaier, Mark Stancil, and participants at the 2019 NYU-Penn Law and Finance Conference and at workshops at Loyola Law School (Chicago) and the University of Virginia. Special thanks to Marcel Kahan for his published comment on this piece and to the numerous market actors who spoke to us about the events we describe. 254 BOSTON UNIVERSITY LAW REVIEW [Vol. 100:253