BoE paper proposes new sovereign debt instruments - → centralbanking.com/central-b … nstruments
A financial stability paper, published by the Bank of England yesterday, proposes two new sovereign debt instruments to boost liquidity and solvency in times of crisis.
In Sovereign Default and State-Contingent Debt , Martin Brooke, Alex Pienkowski, Rhys Mendes and Eric Santor say that recent efforts to resolve sovereign debt crises in Greece, Ireland, Portugal and Cyprus have exposed an “overreliance on official sector liquidity support”.
The authors argue that private creditors should “play a greater role” in the resolution process and, to that end, propose creating sovereign contingent convertible (coco) bonds and GDP-linked bonds.
Sovereign cocos, the paper explains, are bonds that would “automatically extend in repayment maturity” when a country receives emergency liquidity assistance from the public sector. GDP-linked bonds, meanwhile, would directly link principal and interest payments to the level of a country’s nominal GDP.
“While sovereign cocos are primarily designed to tackle liquidity crises, GDP-linked bonds help reduce the likelihood of solvency crises,” the paper says. “This is because GDP-linked bonds provide a form of ‘recession insurance’ that reduces principal and interest payments when a country is hit by a negative growth shock.”
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The CoCos are, I reckon, a good idea. The GDP-linked bonds (GDP-linked anything) are not - they offer perverse incentives…
I actually like the idea of GDP bonds - effectively a hybrid of debt and equity, a bit like convertible bonds.