Corporate v Sovereign Debt, and the Rule of Law: Why the Shift in Investor Appetite?

Being involved in parts of sovereign debt, limited recourse financing, angel investing, and private equity for a few decades, I enjoy the undercurrents associated with debt structures/and related investor appetite for paper. 

The other morning, an article in Bloomberg wrote about investors now preferring company debt versus government.

The following comment I thought was instructive: “It’s the erosion of the perception of rule of law which keeps investors at bay,” said Pilar Gomez-Bravo, London-based co-chief investment officer of fixed income at MFS International, which has around $660 billion under management. “Structurally we do feel that the regime is shifting. People prefer corporate balance sheets which are in better shape than some sovereigns.”(https://lnkd.in/eyDdR7s6)

This is, of course, completely rational, and the US and France are cited in the piece as sovereigns with somewhat bloated balance sheets.

As most know, there are some nuances however in the capital structure of sovereigns, which we have to consider when adjusting our risk scores under the ICRG methodology. And this is particularly true of some emerging/frontier markets and those that are part of larger political and economic unions.

For example, as it affects external debt, we consider the tenor of the liabilities, the denomination, official versus non-official, etc. Months of import cover are sometimes not terribly significant; and fx derived via exports is sometimes rendered relatively meaningless given that remittances in some countries are the prime source of fx.

But the rule of law and the quality of institutions is very significant, and there are a range of empirical studies done using our ICRG data that have found:

1/ Common law countries in Africa are better a protecting rule of law issues than those under civil law systems;

2/ The quality of a country’s institutions, including the rule of law, have better growth prospects and are more adept at providing for income distribution; and 

3/ Maintaining a sound rule of law reduces the likelihood of terrorist events.

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