Pricing Sovereign Debt: Foreign versus Local Parameters

Published date01 March 2018
Date01 March 2018
DOI: 10.1111/eufm.12161
Pricing Sovereign Debt: Foreign versus Local
Michael Bradley
Elisabeth de Fontenay
Irving Arturo de Lira Salvatierra
Mitu Gulati
Fuqua School of Business & School of
Law, Duke University, Durham, NC,
Duke University School of Law,
Durham, NC, USA
Economics Department, Duke
Sovereign bonds may be issued under either local or foreign
parameters. This decision involves a tradeoff between the
sovereign retaining discretion in managing the issue and
relinquishing control to third parties. Examining three key
bond parameters governing law, currency, and stock
exchange listing we find that investors generally consider
foreign-parameter debt to be less risky than comparable
local-parameter debt issued by same sovereign. By
matching the foreign- and local-parameter bonds of
sovereigns that have issued both, we find that, with few
exceptions, both investment grade and non-investment
grade sovereigns are able to issue their foreign-parameter
bonds at relatively lower yields.
contracts, asset pricing, bonds, sovereign debt, currency risk, governing
F33, F34, G15, K12
The authors are grateful to John Doukas (Editor) and two anonymous referees for their very helpful comments and
suggestions. Thanks for comments are also due to Lee Buchheit, Anna Gelpern, Christoph Trebesch, Mark Weidemaier and
Jeromin Zettelmeyer. The authors owe a special debt to Ugo Panizza and Paolo Colla, who not only provided comments
but helped locate crucial data.
Eur Financ Manag. 2018;24:261297. © 2017 John Wiley & Sons, Ltd.
The threshold question faced by any sovereign seeking to raise funds in the bond market is whether to
issue the debt under local or foreign parameters. This choice then determines a number of other key
characteristics of any bond issue such as which underwriters, lawyers, and ultimately investors are
likely to be involved. Most important, the decision involves a tradeoff between the sovereign retaining
control of the issue by relying on local parameters or relinquishing a certain degree of control by issuing
under foreign parameters. Beginning with a sample of 111 sovereigns issuing 22,605 bonds from 1990
to 2016, we examine three contractual factors that are the key determinants of where a particular
issuance falls on the local versus foreign continuum: governing law, currency and the stock
exchange(s) on which the issue is listed.
Recent interest in the question of local versus foreign parameters has been largely motivated by the
restructuring of the debt of Greece in 2012. In March of 2012, Greece conducted one of the most severe
sovereign debt restructurings ever, forcing the majority of its creditors to take haircuts in the range of
6075% of the net present value promised by the issue. Greece was able do this without going into legal
default because it took advantage of the fact that over 90% of its outstanding bonds were governed by
local Greek law. This allowed the Greek legislature to pass a law retroactively inserting in its local-law
debt contracts a provision (formally a retrofit collective action clause) that facilitated the dramatic
restructuring. In contrast, the terms of Greece's foreign-law-governed bonds could not be altered by
Greek legislative fiat, and holders of these bonds who held out during the restructuring were paid in full
and on time.
Others have argued, however, that because it is more likely to be held by domestic voters
or systemically important domestic institutions such as banks, debt issued under local parameters
might, under some circumstances, be harder to restructure (and therefore safer) than debt issued under
foreign parameters (Borensztein, Levy Yeyati, & Panizza, 2006; Guembel & Sussman, 2009). Whether
investors view local or foreign debt as a safer investment remains an open question.
The empirical research on the relative pricing of lo cal versus foreign parame terized bonds is
relatively sparse. Such stu dies have tended to focus exclusively on either currenc y or governing law
alone, have generally been rel atively narrow in scope (focus ing, for example, on the eurozone debt
crisis of 201013), and have foc used on price movements during periods of financial di stress, rather
than on pricing at issuance. Building on the facts of the Greek restructur ing, for example, a number
of researchers have examined w hether investors who held bonds go verned by foreign law fared
better than those who held bonds governed by domestic law as the euro area crisis worsen ed during
the 201013 period.
Consequently, these studies examine a small number of sovereigns nearing financial distress, over
a relatively short period of time and denominated in a single currency (the euro) (Choi & Gulati, 2016;
Schumacher, Chamon, & Trebesch, 2015; Clare & Schmidlin, 2014; Nordvig, 2015). For example,
Schumacher et al. study 100 bonds of 8 sovereigns over the period 2007 to 2014; Clare and Schmidlin
study a sample of 400 bonds from 2008 through 2012; and Nordvig examines 137 pairs of bonds issued
by 7 sovereigns from 2009 to 2014. The general conclusion to be drawn from this literature is that
For details regarding the Greek restructuring, see Zettelmeyer, Trebesch, and Gulati (2013) and Schumacher, Chamon, and
Trebesch (2015). Greece was not the first sovereign to have taken advantage of its control over local law to significantly
reduce its financial obligations, nor will it be the last. In 1998, Russia imposed large haircuts on domestic-law bonds in
order to avoid a full-scale default. Its bonds governed by foreign law were untouched (Duffie, Pedersen, & Singleton, 2003;
Gelpern, 2017). The same occurred with Jamaica in 2000 (Erce & Diaz-Cassou, 2010). During the Great Depression of the
1930s, the US government used its control over the governing law to engineer a transfer of value from creditors to debtors
by legislatively abrogating the gold clauses in all domestic debt contracts (Kroszner, 1998).
investors who held bonds governed by foreign law fared significantly better than those investors who
held bonds governed by domestic law.
In this article, we take a broader view of the question by looking at a fuller set of salient local and
foreign parameters in the typical bond, doing so over a quarter century of data for the entire global
market, and comparing bonds issued in different currencies. Our contribution to the literature on
sovereign debt is threefold. First, we examine a much larger sample in terms of the number of
sovereigns, the number of bonds, the number of bonds per sovereign and the time period covered than
appears in the existing literature. Second, we focus on when-issued prices as opposed to prices in the
secondary market. Relying on pricing at issuance allows us to measure how investors price local-
versus foreign-parameter debt ex antethat is, prior to any eminent threat of financial distress. Third,
we examine several parameters simultaneously as opposed to examining only one parameter in
isolation. More broadly, and beyond the sovereign debt literature, we believe we have made a
contribution to the literature on the price impact of bond covenant provisions (e.g., Bradley & Roberts,
2015; Eichengreen & Mody, 2004).
As illustrated by the Greek experience, having its debt governed by local law gives a sovereign
debtor leeway in restructuring its debt in times of a crisis. A similarly powerful weapon is having the
debt denominated in local currency. As an historical matter, several governments in financial crisis
have exploited the fact that their debt was denominated in domestic currency and increased their money
supply in order to inflate their way out of their debt obligations (Gelpern, 2017; Reinhart & Rogoff,
2009 and 2011). If interest rate parity holds, there should be no difference in pricing between foreign-
currency and local-currency debt, after adjusting for expected inflation. Yet the interest rate parity
relation assumes no difference in credit risk. The question is thus how credit risk is affected by whether
the sovereign controls the currency in which the bonds are denominated.
Research on a sovereign's choice to denominate its debt in local or foreign currency has largely
focused on the fact that, until recently, many emerging market issuers have not been able to borrow in
anything but foreign currencies (Eichengreen, Hausmann, & Panizza, 2005). Another strand of the
literature focuses on the choice of foreign- or local-currency debt primarily from the sovereign's
perspective, weighing the numerous tradeoffs involved in selecting its aggregate debt mix (see Panizza,
2008 for an overview). Incorporating the investor perspective, there is some research indicating that
yields on domestic currency bonds are higher than those denominated in foreign currencies, but this
research has focused only on emerging market issuers and their choice of currency (see Gadanecz,
Miyajima, & Shu, 2014, for a review of this literature).
A third factor that may give a sovereign breathing room in times of crisis is having its bonds listed
on a local rather than a foreign stock exchange. Stock exchanges are the primary regulators of the
sovereign debt market and dictate the periodic disclosures that debtors must make to investors. Leeway
from the exchange in terms of what information the sovereign has to disclose and when it must be
disclosed could help buy the sovereign valuable time during a crisis. As best we are aware, however,
there is no research examining the pricing impact of foreign versus local listing in the sovereign debt
market. A related literature in the corporate area finds that firmsstock prices increase when they list
their stock in a foreign jurisdiction with stronger disclosure and investor protection requirements such
as the US (Doidge, Karolyi, & Stulz, 2004). One proposed rationale is that subjecting the firm to the
stricter listing and reporting requirements of the SEC and US exchanges can reduce the ability of
management to expropriate wealth from its stockholders (Karolyi, 2006; Witmer, 2006).
One might therefore presume that creditors would always prefer that sovereigns denominate their
bonds in foreign currencies, have them governed under foreign law, and list them on a foreign stock
exchange. After all, local-parameter debt gives the issuing sovereign a home fieldadvantage in any
disputes with its investors. This is particularly true if the sovereign experiences financial difficulties

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