Syndication of large loan or share issuances became increasingly common in the 18th and 19th centuries. This model of raising money allowed for smaller investments to be pooled together to make a larger investment than any one participant could make on their own. It also allowed a secondary market, one formed for ownership of the securities to change hands after the original investment is made, to develop. These advantages lowered the cost, and increased the volume, of capital raised in comparison to simple bilateral loans.
However, when things go wrong, a diffuse investor-base cannot put forward a common position in negotiations as easily as a single investor. The problem is compounded in sovereign bonds where remedies are few. In Britain, one attempt at a solution to this problem was the creation of the Corporation of Foreign Bondholders.
Sovereign Defaults
The 19th century saw rapid growth in sovereign bond issuance, centered on London where countries in Europe and the Americas raised money. Compared to other investment opportunities, these loans had novel risks. Unlike other borrowers, governments benefit from sovereign immunity; creditors’ have correspondingly limited ability to exercise any effective remedy.
The diverse nature of bondholders may also complicate matters especially when recourse is already so limited. If a government defaults, competing interests among creditors may harm bondholders. For example, back in the 16th century, Genoese bankers kept lending to Philip II’s Spain even after the latter’s default, making other creditors’ threats to withhold future credit ineffective. As another example, holdouts against a settlement may harm both debtor and creditors alike.
British Bondholders
London was the premier capital market for sovereign debt from the 1820s onward. When many foreign loans turned sour there starting from that very decade, bondholders had few options in bodies to represent them. Bankers played a role as intermediaries but they were naturally conflicted, being representatives of both the bond issuer and the investors. They were thus incentivized to arrange a settlement because often only that could re-open the bond market for the defaulting country, their client. However, this could encourage banks to favor inadequate settlements for bondholders.
That said, the more reputable banks were more interested in striking deals favorable to creditors and these banks generally avoided underwriting riskier issues anyway. By contrast, less reputable banks were more dependent on business from less creditworthy governments and thus were less interested in applying pressure on them on behalf of creditors.
Alternatively, creditors could form an independent, often ad-hoc, committee to represent themselves. In London, these became increasingly common in the 1820s and 1830s. Interestingly, some names appear multiple times in these committees, suggesting some made a living trading in defaulted bonds and influencing eventual settlements. In any case, these ad-hoc committees had their own shortcomings; forming such a committee introduced a delay in the settlement process. Duplicative organizations for afflicted bondholders may also develop and rival groups may seek redress separately, diminishing their power.
So, after some time, a permanent solution was eventually arrived at. A meeting was arranged in London for holders of foreign bonds on November 11, 1868 and a resolution was passed to create a council representing bondholders. A report setting out the hypothetical structure of this council was approved on February 2, 1869, establishing a bondholders’ association. There was a possibility of making this association a for-profit company but it did not develop in this direction.
Regardless, this bondholders’ association was incorporated in 1873 as the Corporation of Foreign Bondholders. In the meantime, the old association had raised money by issuing £100 bonds to 1,000 members and these amounts, intended to get the organization off the ground, were repaid by the new corporation by 1885. During the early days, membership dues were introduced to fund the Corporation of Foreign Bondholders, available for payment on either a permanent basis or by a recurring subscription but this was a short-lived means of covering the corporation’s costs. In the end, the organization would fund itself through the revenues of an endowment and commissions earned on cases that it settled.
The Corporation of Foreign Bondholders became a semi-public body with an Act of Parliament in 1898. It would be governed by a council comprising bondholders and some members nominated by the British Bankers’ Association and the London Chamber of Commerce. These committee members would include, at times, directors of the Bank of England and the chairmen of large banking firms.
Procedures
When a default on a foreign government bond occurred, the Corporation of Foreign Bondholders could be petitioned to take up the cause of bondholders. The organization would then try to ascertain the extent of British holdings of the affected securities. If holdings were large enough, a committee would then be established to address the particular country’s default. If not, then bondholders would need to organize themselves by a different means, perhaps even by tagging along with bondholders outside of Britain.
If established, the committees would advise but would not enter into binding agreements with defaulting governments itself. Before a settlement was ratified, reports of the committee would be discussed at general meetings of bondholders. Individual bondholders would ultimately retain discretion on whether to accept a settlement or not, a process which usually involved turning in bonds for new ones or having new terms stamped over the old securities. Nonetheless, the recommendation of the Corporation of Foreign Bondholders, ratified by a majority in a general assembly, went a long way towards facilitating a settlement offer to begin with.
The Corporation in Action
Some defaulting borrowers were more forthcoming than others. As noted earlier, remedies are not numerous when dealing with a sovereign borrower. To encourage a borrower to negotiate a settlement, the Corporation of Foreign Bondholders would coordinate with exchanges to lock a defaulting government out of capital markets. The London Stock Exchange, for instance, already had a rule prohibiting new issues from being listed by governments with existing loans in default and which had not been negotiating in good faith with creditors. The Corporation of Foreign Bondholders supplied information to the exchange on defaulted bond issues and the status of negotiations.
Of course, as with any such sanction, enforcing a financial embargo against a defaulting government required unity. The corporation was not successful in maintaining a united front every time. In the case of an 1870s Mexican default, a group of bondholders formed a rival committee of bondholders. At the same time, this does not mean all settlements were contentious.
For example, a settlement reached with the government of Colombia in 1889 was approved unanimously by the Corporation of Foreign Bondholders’ general meeting. That arrangement saw a defaulted loan at 4.75% interest converted into a new loan of 3% interest for the first 10 years and 4% thereafter. Principal was converted at par but the old bondholders’ accrued interest up to that date was essentially written off by more than half. The terms set out that payments be made in gold and £12,000 per year was allocated to a sinking fund to gradually redeem the bonds. At least a little reassuring to bondholders, Colombia did not raise a new loan in conjunction with the settlement plan.
Defaults and settlements often came in waves. Decades later, during the Great Depression, the Corporation of Foreign Bondholders was involved in restructurings of debt that involved suspension of sinking fund (or amortization) payments and allowing payments to be made in domestic instead of foreign currencies.
How did the bondholders fare? In a series of defaults prior to 1914, those in which the Corporation of Foreign Bondholders itself, or other very similar international organizations, were involved saw a higher return to bondholders than those in which other intermediaries, like investment banks, represented bondholders. This research by Rui Pedro Esteves of the Graduate Institute of International and Development Studies is resilient even to possible claims of selection bias, namely that the corporation represented creditors only in cases where the default was likelier to lead to a good recovery to begin with.
Equivalents Elsewhere
The Corporation of Foreign Bondholders was the first of this form of organization but other creditors have formed similar organizations in other countries. The next was the Vereeniging voor den Effecthandel, founded in the Netherlands in 1876. Protecting French investors was the Association Nationale des Porteurs Franqais de Valeurs Mobilibres, formed by the Chambre Syndicale des Agents de Change (CAC) in 1898. This entity was very similar to the British organization. The Corporation of Foreign Bondholders Act, passed in the United States in 1933, led to the creation of an American equivalent, the Foreign Bondholders Protective Council.
Other organizations representing bondholders were formed in Belgium and Germany and in Italy and Switzerland, industry associations of bankers took up this responsibility. In different times and places, the role of these entities differed as did the attention paid to them by governments. French and German governments intervened in the cause of bondholders more readily than in Britain, where private creditors needed to seek their own recovery without much government involvement.
That said, creditor government involvement in sovereign debt issues increased with the European Sovereign Debt Crisis of the early 2010s. Another legacy of that crisis was the emergence of collective actions clauses in bond agreements, which allow a supermajority of bondholders to reach a decision that will be binding on all holders. While distinct from a device such as the Corporation of Foreign Bondholders, these arrangements all attempt to address the tricky relationship between state borrowers and private, and often foreign, creditors.
Lesson
Sovereign debt crises were commonplace in the 19th century and the Corporation of Foreign Bondholders is a part of the history of these debt crises. The experience of 19th century defaults illustrates that even sovereign borrowers could be encouraged to negotiate with creditors. The denial of future credit is a fairly effective remedy. However, this requires coordination, both to implement such a financial embargo and to seek the best possible settlement for bondholders. Disunity often led to worse outcomes. Despite these lessons, the management of these crises is hardly straightforward nowadays. Settling sovereign debts is a process that remains subject to much awkwardness.
More from the Tontine Coffee-House
Read about debt crises and their resolutions in 19th century Egypt, Greece, and the Ottoman Empire as well as another body focused on debt restructuring, the Paris Club. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
Further Reading
1. Annual General Report of the Council of the Corporation of Foreign Bondholders 1889. Corporation of Foreign Bondholders, 1889.
2. Esteves, R. P. “The Bondholder, the Sovereign, and the Banker: Sovereign Debt and Bondholders’ Protection Before 1914.” European Review of Economic History, vol. 17, no. 4, Nov. 2013, pp. 389–407.
3. Flandreau, Marc. “Collective Action Clauses before they had airplanes: Bondholder committees and the London Stock Exchange in the 19th Century (1827-1868).” Graduate Institute of International and Development Studies Working Paper, No. 01/2013, 2013.
4. Wynne, William H., and Edwin M. Borchard. “Foreign Bondholders Protective Organizations.” The Yale Law Journal, vol. 43, no. 2, 1933, pp. 281–96.
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