The Interplay Between the Pricing of International Arbitration Awards and Sovereign Bonds

I was delighted to attend the "Thought Leaders 4 Disputes Sovereign & States Disputes and Enforcement" conference at the Law Society today with Raphael Kaminsky of Teynier Pic .?One excellent intervention by Yasmin Mohammad of Fortress Investment Group and Nikos Asimakopoulos of Sigma7 Alaco concerned the relevance of sovereign bond pricing to the valuation of arbitration awards against the same sovereign.?This is an issue we have always considered extremely important for award valuation.?

For the purposes of this exercise, we look at bonds and awards owed by the same sovereign, so (provided you look at the right bond series) the price of one is naturally relevant to the value of the other.?There are important differences however.?Bonds are liquid and screen-tradeable.?Awards are not. Bonds represent debt consensually contracted by the sovereign debtor. Awards do not; they represent litigation liabilities.?Bonds are (usually) widely traded.?Awards are not.?Even when bonds are in default, there are numerous mechanisms and best practices available to bond holders, and often the ability to act collectively.?There is nothing similar for awards, although we believe that the time is fast approaching where there should be, and we are working on an initiative to facilitate this.

Finally, and most importantly, bonds are (usually) held by institutions that are in the business of holding sovereign debt.?By contrast, arbitration awards are often perfect examples of dislocated credit, i.e. sovereign debt held by entities that did not start out with the intention of becoming a sovereign creditor at all, and often with little in-house capacity to manage their newfound status as a sovereign creditor.??

To us, the above factors suggest the following:?

1. It is right for sovereign award creditors to consider selling their awards to investors who are better able to hold and recover those award debts.?
2. It should not be surprising that awards trade at a discount to comparable bonds because those bonds act as a benchmark, from which further deductions must be made to account for things like illiquidity, cost of recovery and uncertainty of recovery, etc.?
3. However, this situation can lead to a logjam, where award holders are reluctant to sell at the prices that are offered, but bidders are unable to offer higher pricing, given the inevitable expenses involved in recovery via contested enforcement. This simply serves to perpetuate, indeed exacerbate, the credit dislocation.
4. To compound matters, these awards often bear interest at above market rates, thus degrading the sovereign's debt profile ever further. (This is another issue that does not get enough attention.)
5. By contrast, the sovereign should -- if properly advised -- recognise its award liabilities, because only in so doing can it obtain the optimal outcome. Often, it will be able to "refinance" this arbitral indebtedness by replacing it with bond debt at much lower, market rates.
6. This would bring us "full circle," where awards are first valued by reference to sovereign bonds, i.e. a reflection of sovereign creditworthiness, and then later repaid by the proceeds of a subsequent bond issuance. In this way, this market for the arbitration awards can evolve, ultimately opening itself to more patient sources of capital, which can, in turn, offer more attractive pricing to award holders. Those award purchasers should then be able to offer more constructive, consensual solutions to their sovereign debtors.

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