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Law firm Jones Day prepares for emerging market debt defaults

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Global law firm Jones Day has set up an internal working group to address legal issues arising from upcoming defaults in emerging market corporate debt securities held by institutional investors.

Jones Day has been engaged by an unnamed large global bank with significant exposure to Indian corporate debt, according to Ferdinand Mason, a partner at the firm.

The bank asked the firm to analyse the legal landscape and “look for ways to avoid the Indian jurisdiction if necessary” when recouping potential losses from corporate defaults.

The law firm warns that a wave of defaults in emerging market corporate debt is likely to hit investors in the asset class.

This is signalled by the high leverage multiples seen within emerging market corporates, particularly in Asia.

“We’re looking at anything between $15trn (€13.5trn) and $18trn of emerging market corporate debt, half of which is held by local banks and the other half by bondholders, primarily based in the US and UK,” Mason said.

“If you look at M&A activity at the moment, you have Chinese companies buying mega US, UK or EU corporates with leverage levels several times higher than their targets. The debt levels are just incredible, and it’s all funded by the Chinese banks.”

Mason explained that some emerging countries were engaging in what could be seen as state aid, by allowing local state-owned banks to roll over maturities of corporate debt.

If that is the case, such countries could be in violation of trading treaties with Western economies.

“That debt is vulnerable. It could be nullified, or it could be void, becoming a disaster at the end of the road for the ultimate investors, all the way up to the bondholders,” Mason said.

“When the credit of local banks becomes vulnerable, the first thing governments will do is take care of its banks. There will be less concern about issuing vehicles outside its jurisdictions.”

The firm is advising institutional investor clients to “get ready now”.

“It’s time now to start getting compliance teams and risk management groups together to understand the issue and have a road map to make sure everybody understands what the best angle is in terms of enforcement,” Mason said. 

According to Jones Day, many issuers of hard currency emerging market corporate debt have structured vehicles based in jurisdictions outside their countries of origin, such as Luxembourg, the Cayman Islands or the British Virgin Islands.

That is where legal advisers may be able to negotiate terms to recoup assets in cases of defaults.

“The world of distressed debt in 2016,” says Mason, “has become very multi-jurisdictional.”

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