3M's Aearo Technologies' Bankruptcy: the Hoosier Hop

3M's earphone subsidiary, Aearo Technologies, filed for bankruptcy today in the Southern District of Indiana. This is looking like a really interesting case: it looks like a new generation of the Texas Two-Step strategy. Let's call it the Hoosier Hop. Here's the story.

Do Investors Really Prefer Putin’s Booby Trapped Bonds?

Mark Weidemaier and Mitu Gulati

We have written before about the “Alternative Payment Currency” clause in some Russian bonds, the one that allows for payment in rubles if, for “reasons beyond its control,” the government can’t pay in dollars or euros (or a subset of alternative currencies). Our general take on the clause was that it is a bit odious. That’s because we viewed it as way for investors to subsidize bad behavior by the Russian government. If the Russian government gets sanctioned, investors will help it out by taking on the currency risk associated with being paid in rubles. And we were not the only ones. Jonathan Wheatley of the FT, writing in 2018, when these clauses were introduced, quoted an investor this way:

“I cannot understand why any foreigner would take the risk of being paid out in roubles,” said one London-based asset manager, adding that many foreigners were likely to buy the bonds without reading the prospectus thoroughly.

Gazprom, the Russian state-owned gas producing giant, also began using these ruble option clauses in its foreign currency bonds at roughly the same time (here). Importantly, for our purposes, it was clear to all involved at the outset that these clauses were put in place in anticipation of western sanctions in the event that Russia were to engage in misbehavior (e.g., invading neighbors).

From first principles, we would have assumed a bond with this APC clause would be viewed as relatively unattractive compared to a bond that required payment in dollars or euros. Bonds denominated in foreign currency protect investors from the risk of devaluation in the borrower’s currency. If investors are less willing to lend in domestic currency, that should make the cost of borrowing in foreign currency lower. If one looks at broad trends over time, that’s mostly what we see. Poorer and lower-rated countries do seem to pay more to borrow in local currency than in foreign currency (here). By contrast, rich, highly-rated sovereign issuers borrow pretty much only in their local currency.

Moreover, the APC clause could be invoked opportunistically by the Russian government in circumstances where it isn’t actually impossible to pay investors in hard currency. That risk is probably small for a country with a long-standing reputation for good behavior vis-à-vis its obligations to the rest of the world such as the Netherlands or Germany.  But would anyone put Russia in that category, especially Russia under Putin after its repeated and extreme violations of international obligations? A clause that allows misbehavior by a counterparty known for its willingness to misbehave should make these bonds less valuable. Indeed, we’ve seen just that with Argentina after it engages in shenanigans vis-à-vis bondholders (here).

Given these principles, here is what we would have predicted: