100 Years of Incompetence and Provincialism: “In the Name of the Republic”

"Utter Incompetence'' and ''Provincialism'', was how President Masaryk reputedly[1] described the Czechoslovak Finance Minister and actions of the Ministry of Finance in 1924 in relation to debt issued ''In the Name of the Republic''. Fast forward almost 100 years and not a lot has changed.

President Masaryk's harsh remarks came after the then Finance Minister, Bohdan Becka, had sent a virtually unknown banker to London to try and negotiate a second tranche of the 1922 Czechoslovak State Loan. Not only did the MoF fail to receive the additional loan, according to President Masaryk, by demonstrating such ''provincialism'', its actions damaged the reputation of the country. The original Czechoslovak loan had been personally negotiated two year's earlier by no less than the then Prime Minister, Edvard Benes, and the President's son, Jan Masaryk.

Not only was the 1922 Czechoslovak State Loan the first international bond ''In the Name of the Republic'', it was the first such loan by any central-European state in the aftermath of WW1. As such, the bond issue was a source of international recognition, pride and prestige.

While the current Minister of Finance, Alena Schillerova, recently unveiled another bond issue ''In the Name of the Republic'' no mention was made of the ongoing default on some of the original loans, default on a 1986 Settlement (which should have seen these bonds repaid), or use in 1989 of sovereign immunity to avoid claims. ''Err, wot, it can't be true'' I hear you say. Sadly, it is very true. The shoddy treatment of these investors remains a closely guarded secret by the Czech Ministry of Finance.

[1] Referred to in a paper by Kubů, Eduard, Šouša, Jiří. The Czechoslovak Loan of 1922: Meeting Place of Financial Elite of London and Prague, 2010. 

Left: Gift certificate for current bond issue ‘’In the Name of the Republic’’. Right: Unrepaid Czechoslovak 1922 dollar bond showing a stamp of acceptance and eligibility (in red) to a 1986 Settlement.
Left: Gift certificate for current bond issue ‘’In the Name of the Republic’’. Right: Unrepaid Czechoslovak 1922 dollar bond showing a stamp of acceptance and eligibility (in red) to a 1986 Settlement.

The Settlement

In 1986, a 'Final Settlement' was signed which offered most investors in the original dollar loans issued ''In the Name of the Republic'' 98% of the face value of their bonds: A not an unusual settlement for the time. A small group of investors, who happened to hold bonds that had been subject to a New York Supreme Court judgement against the Czechoslovak State (the so called Augstein bonds), were offered just 20% of their face value.

While the Settlement included the outstanding dollar bonds issued by the Czechoslovak State in 1922, it also included dollar bonds issued by the City of Greater Prague in 1922 and City of Carlsbad (Karlovy Vary) in 1924, whose liabilities had also been assumed by the state in 1946.

The terms of the Settlement called for an initial 80% funding by the Czech State and then additional funding as required.

The Default

The majority of investors tendered their bonds in 1984, received a stamp of eligility and acceptance, and an initial 2½ % payment on account, and then had their bonds returned to them pending the Final Settlement which was announced in 1986. The Final Settlement provided for an additional 95 ½ % of face value, bringing the total to 98 % of face value.

During the course of 1987, most bondholders received the additional 95 ½% payment and their bonds were duly cancelled. Then, suddenly and inexplicably, in early May, 1987, the money ran out. Requests by both the government's paying agent, Irving Trust, and by the body representing bondholders, The Foreign Bondholders Protective Council (FBPC), were ignored. Though Section 4 of the Settlement called for additional funding as required, that funding never happened. That is why, even today, there remain un-cancelled dollar bonds, most bearing the stamp of eligibility and acceptance of the Settlement. Incredibly, the Czechoslovak Ministry of Finance (MoF) had defaulted on the Settlement when it was estimated just an additional $1/4m of funding was required. Just how small minded and provincial can one be?

The Use of Sovereign Immunity

The Augstein Bondholders who had been offered just 20% of the face value of their bonds tried to sue both the MoF and the FBPC. In Jacob Oliner, v. Czechoslovak Socialist Republic and Foreign Bondholders Protective Council (1989), the Czechoslovak State invoked Sovereign Immunity. As a result, the action against the FBPC had to be dismissed as well. It was clear, with the use of Sovereign Immunity bondholders had no means of redress. Shaken by the lawsuit, the FBPC, the body representing bondholders, became inactive and disbanded.

Small Investors Worst Hit By Default

As is so often the case, it was small investors, mostly Americans of Czechoslovak origins, the patriots who, according to the President of the FBPC, had bought the bonds in ''their local churches and societies to support the motherland'' that suffered most. While professional investors based in the big cities submitted their bonds promptly for payment, it was the numerous small private investors living outside of New York (and indeed some living abroad) that submitted their bonds too late. With the FBPC now inactive, without knowledge of the precise terms of the Settlement, and told by the paying agent the money had ''run out'' these small investors had no means of redress. Even if they had tried to sue in the US courts, it's likely Sovereign Immunity would have been invoked again, as in the case of the Augstein bonds.

What Settlement? What Default? What use of Sovereign Immunity?

From 1993 onwards, the Czech State, its agencies, and the City of Prague issued bonds once more. The offering circulars make no mention of the history of default, the 'Final Settlement' or use of Sovereign Immunity. With the FBPC inactive, the Czech MoF has been careful not to disclose the terms of the 1986 Settlement. In a typical Czech conflict of interest, the MoF, the same institution that defaulted on the bondholders' Settlement, through the 1990's, also acted as the financial market Supervisory body tasked with protecting investors. [Yes, bit of a laugh!]. Even today, the MoF remains the main Ministry for proposing market legislation and retains within its remit certain supervisory activities, e.g. Financial Analytical Unit. In effect, ''a fox has been put in charge of the henhouse''. The MoF's own capital market activities falling outside the supervisory remit of the Czech National Bank. In short, the MoF has been allowed to play by different rules than other market participants.

In 2015, controversial lawyer, Edward Fagan, asked questions about the unpaid Carlsbad (Karlovy Vary) bonds. It was the vague and evasive answers of the MoF, alluding to the 1986 Settlement, but failing to divulge its contents, that first piqued this author's interest to investigate the matter independently. Despite the author owning, in a private capacity, some of the unrepaid bonds, stamped as eligible and assenting to the 1986 Settlement, repeated requests to the MoF for a copy of the Settlement were ignored.

Default, Deceit, and Non-Disclosure

That might have been the end of the matter. Unfortunately for the Czech MoF, buried deep in the FBPC archives at Stanford University Libraries, a signed copy of the 1986 Settlement recently came to light: Within the terms of the Settlement, it is clear the MoF committed not to a one-off payment, but to fully fund the settlement making additional payments as required.

Additional Funding ''as shall be required''

Clause 4, 1986 Final Settlement.
Clause 4, 1986 Final Settlement.

The MoF's default, deceit, and non-disclosure is laid bare: There had indeed been a default on the Settlement. That the post-Communist MoF has repeatedly tried to hide this fact from future investors, journalists, and even, we understand, issuing banks and their appointed legal advisers, is truly pathetic. The political system may have changed but the MoF's broken and provincial culture hasn't. The MoF should have learnt from the series Yes Minister: Never try and hide information that can be found from other sources!

On the 25th April, 2019 the author, a professional fund manager, wrote to the MoF asking: ''Why the history of default and use of sovereign immunity is missing from all bond offering circulars since 1993?'' In particular, reference was made to the issuance documentation of the Czech Republic's 4.125 % maturing 18/03/2020 listed on the Luxembourg Exchange. The MoF dodged the question. Instead, issuing banks will be delighted to know, on the 27th August, Karel Tyll, Deputy Minister of Public Budgets replied:

''Legal opinion of this issuance documentation and its subsequent updates was provided by external legal advisors who were secured by arrangers of the programme. Let me note that external legal advisors did not find any material omissions.''

Well, there you have it, shamelessly, the MoF has 'passed the buck' for any omissions onto its issuing banks and their legal advisers.

Separately, on 21st June, 2019, two months after the author's letter to the MoF, Bloomberg reported that the Czech MoF had decided to ''curb its Eurobond sales'' ostensibly ''to avoid the cost and procedure of hiring arrangers, organizing roadshows, and compiling lengthy prospectuses''. [Author's Note: Future Eurobond issues will therefore be on the domestic market, without a prospectus, and subject to Czech law]. 

Hypocrisy and Double Standards? In August, 2020, the MoF announced plans to ‘’fight against fraudulent bonds… [Especially] corporate bonds without a prospectus’’.  Not only will the MoF not itself in future issue prospectuses, risk warnings on the website: www.dluhopisrepubliky.cz are notable by their absence. It truly is one rule for the MoF and another for everyone else.
Hypocrisy and Double Standards? In August, 2020, the MoF announced plans to ‘’fight against fraudulent bonds… [Especially] corporate bonds without a prospectus’’. Not only will the MoF not itself in future issue prospectuses, risk warnings on the website: www.dluhopisrepubliky.cz are notable by their absence. It truly is one rule for the MoF and another for everyone else.

However, it is not just the issue of 'material omissions', and there are no more material omissions than default and the use of Sovereign Immunity: It is a generally accepted principle that an issuer shouldn't issue new debt while still in default on a prior issue.

Broken Culture and Lack of Accountability

In 1924, when the MoF sent an unknown Czech banker to London requesting an additional issue of Czechoslovak bonds, investors already sensed a lack of commitment.

Perhaps it should have therefore come as no surprise that the MoF defaulted in 1987 when a paltry $1/4m was required. This act of pettiness is symbolic of the childish and provincial culture that has pervaded the Ministry of Finance over the last 100 years. Nor has this anything to do with Communism: While the US Foreign Bondholders Protective Council (FBPC), and its British equivalent, brokered over 50 such agreements during the 1980's, with numerous (mainly Communist) countries, this was the only time the author has identified where, once signed, there was an actual default on such a Settlement. Coincidentally, in 1987, the same year the Czechs defaulted, Communist China honoured a settlement with British holders of its defaulted debt repaying, on similar terms to the Czech Settlement, obligations as diverse as a 1934 Shanghai Cricket Club Debenture and a 1913 Chinese Government Gold Loan.

Over successive decades, by hiding the terms of the Settlement, default on that Settlement, and use of Sovereign immunity (against the Augstein bondholders), the MoF has enjoyed the free use of other people's money for 30 years: Congratulations!

A Need for Reform

Are we really to believe that from 1993 onwards, when the Czech State, its agencies, and the City of Prague issued prospectuses, officials had 'forgotten' the default in 1987 and their use of Sovereign Immunity in 1989? No, of course not. Instead, it looks like these were deliberate acts of omission to avoid embarrassment and to avoid honouring the Settlement. As recently as 2015, in iDNES.CZ, a MoF spokesman was quoted asserting''The offer was accepted by the American side and confirmed by an international agreement."No mention of default on that Settlement.

In the context of such half-truths, one has to ask: Should the MoF...

  • ...remain the lead ministry for proposing capital market legislation?
  • ... remain the lead ministry responsible for capital market development/strategy?
  • ...have continued capital market supervisory responsibilities, e.g. Financial Analytical Unit (FAU)?
  • ...have had better oversight?

Few would argue with the fact that the MoF's policies towards the Czech capital market have been disastrous, notable by successive scandals and outright fraud. The former Finance Minister, and current Prime Minister, remains under criminal investigation for subsidy fraud and accused of hiding continuing control of his business interests.

What's the answer?

Well, apart from honouring the 1986 Settlement, this author, having managed money in different jurisdictions over a career spanning more than 30 years, believes more fundamental change is needed.

As is the case in the UK, the Industry Ministry should be the lead ministry for proposing capital market legislation and formulating overall strategy. Given the disappearing boundaries between industries, e.g. Finance, Technology, Retail, a more holistic approach to industrial strategy makes sense.

The FAU should of course be under the remit of the Czech National Bank (CNB), the capital market's main supervisory body; a respected institution that has 'independence' written into its founding statutes.

The capital market activities of the MoF (like other market participants) should be under the supervision of the CNB.

Bringing the Country into Disrepute

Few readers will be surprised by yet another sorry tale of official deceit. Issuing new bonds ''In the Name of the Republic'' while continuing to be in default on a prior issue. This staggering act of hypocrisy will have done nothing to build trust and confidence in the Czech capital market. As with Becka's actions in 1924, it will also have damaged the country's reputation. Not so long ago, the British government repaid 300 year old debt, dating from the 1720s, the Czech government seems to have problems honouring a Settlement made just 30 years ago.

Nobody has ever doubted the ability of the Czech Republic to honour its debts, however, thanks to the repeated actions of the MoF, one must question the country's willingness.

Jeremy Monk
Investment Director,
AKRO investiční společnost, a.s.
Prague. 27th January, 2021

Afterword

It should be stressed, that while the author holds some of these uncancelled bonds, neither AKRO investiční společnost, a.s. or any of the funds it manages has any direct interest in these bonds or in fact holds any Czech government debt.

Many of AKROs clients, especially former investors in the CS Funds, whose funds were 'tunneled' in 1997 after repeated acts of maladministration by MoF officials, are only too aware of the broken culture and lack of accountability at the MoF.

For the purposes of reference, there is a link below to the Settlement the MoF has refused to divulge.

The 1986 Settlement (English)

Disclaimer

This article does not constitute investment advice or a recommendation to buy or sell any security.