Just last week I posted about the "Majority Voting Provisions" proposed to facilitate restructuring of sovereign loans. And now a new innovation has been introduced into the usually sleepy world of sovereign lending.
On "finance day" at COP27, the UK's export credit agency (UK Export Finance) has announced that it is introducing Climate Resilient Debt Clauses ("CRDCs") into its direct lending sovereign loans to low-income countries and small island developing countries. On the same day, the International Capital Market Association ("ICMA") (in association with various other bodies) also published a term sheet for CDRCs in sovereign loans.
CRDCs will allow for debt repayments to be deferred in the case of a severe climate shock or natural disasters. The benefits of UKEF's CRDCs include:
- No cross-defaults: deferrals under the CRDC will not constitute an Event of Default, avoiding triggering cross-defaults on other financings of the borrower.
- Payment deferrals: If the CRDC is triggered, principal and interest payments due to UKEF can be suspended for 12 months, and will thereafter be repayable over a 5-year period.
This is a really interesting innovation, so hats off to UKEF for taking the lead among the ECAs. I'm sure is going to be well-received by sovereign borrowers. My thoughts on CRDCs are as follows:
- Improved efficiency - In the past, lenders like UKEF would ultimately be likely to agree to payment deferrals in the case of a major climate shock/natural disaster affecting a sovereign borrower. However, the negotiation process could be time-consuming and expensive, cross-defaults would likely be triggered, and government officials would likely be distracted from dealing with the immediate local emergencies. Agreeing the deferral up-front with a CRDC avoids those issues, and gives the borrower comfort that it will have some breathing space in case of a climate shock/natural disaster.
- Force majeure - There's an interesting parallel here with force majeure clauses. These are common in supply contracts, whereby the parties' obligations (e.g. to deliver a product) will be suspended for a period while a force majeure event (e.g. fire, flooding, earthquake, war, civil unrest etc) is in effect. However, the conventional position is that force majeure clauses have no place in loan agreements (the thinking being that the borrower should be on the hook the repay the debt when due, regardless of any force majeure event). The CRDCs introduce an element of the force majeure clause into these sovereign loans, giving the borrower some relief when it is most needed.
- Commercial debt - UKEF is part of the UK government, so CRDCs in UKEF direct sovereign loans can be seen in the context of government-to-government relations. It will be interesting to see whether lenders under commercial loans to sovereign borrowers will also adopt CRDCs.