There would be worries that adding cocos to sovereign bonds might raise governments borrowing costs.

Adding cocos to government bonds will require solving a host of technical problems.

It is no secret that sovereign bonds carry significantly higher borrowing costs than concessional debt does.

The healing process is also evident in Europe, though, unfortunately, it is effectively limited only to sovereign bond markets.

Sovereign cocos have the advantage that their activation would not constitute a credit event triggering the credit default swaps written on the bonds. The existence of large quantities of CDS, together with uncertainty about who has written them, has fed the reluctance to proceed with restructuring.

Sovereign obligations, such as bonds, are commonplace in the capital markets, and demonstrate strong investor demand and confidence.

The ECB s announcement of a new program to purchase sovereign bonds has lowered market interest rates.

In fact, the success of banks in issuing cocos suggests that investors do have the appetite for them.

So why are an increasing number of developing countries resorting to sovereign bond issues? And why have lenders suddenly found these countries desirable?

Noting the increasing voluntary use of collective action clauses in sovereign bond contracts by both developing and developed countries,

Countries contemplating joining the bandwagon of sovereign bond issuers would do well to learn the lessons of the all too frequent debt crises of the past three decades.

While Europe has succeeded in stabilizing its sovereign bond markets, financial intermediation for small and medium size enterprises remains highly disrupted.

To ensure that their sovereign bond issues do not turn into a financial disaster, these countries should put in place a sound, forward looking, and comprehensive debt management structure.

Investors subsequent efforts to price in the risk of a eurozone breakup not the volume of sovereign debt caused bond yields to spike.

Extending this idea to sovereign debt, government bond covenants could stipulate that if a sovereign s debt GDP ratio exceeds a specified threshold, principal and interest payments to bondholders would be automatically reduced.

It could do so by buying Italian and Spanish bonds in the secondary market with the pre announced intention of keeping their sovereign interest rates below a certain threshold for a certain time.

A decent pan European economic recovery, and successful gradual fiscal consolidation, would allow the distressed sovereign bonds to rise in value over time. Until then, the jockeying will continue over who will bear the losses, when, and how.

To the extent that this new lending is based on Africa s strengthening economic fundamentals, the recent spate of sovereign bond issues is a welcome sign.

Objections to the idea start with the question of whether there would be adequate demand for these novel sovereign debt instruments. In fact, the success of banks in issuing cocos suggests that investors do have the appetite for them.

NAIROBI Until the global financial crisis erupted four years ago, sovereign bonds had traditionally been viewed as reliable, virtually risk free investments.

And, to the extent that there is even an informal price target associated with the ECB s commitment to purchase bonds, foreign outflows, at least from the sovereign bond market, are automatically replaced, in full, with ECB cash.

In the eurozone, banks are vulnerable to sovereign debt crises because they hold a lot of government bonds frequently issued by their country of origin.

This rendered potentially insolvent commercial banks, whose balance sheets were loaded with such bonds, giving rise to Europe s twin sovereign debt and banking crisis.

It was not a populist message, because the ECB does indeed have the firepower to buy enough sovereign bonds on the secondary market to put a ceiling on interest rates, at least for many months.

Until recently, the bond markets treated all euro sovereign debts as virtually equal, not raising interest rates on high debt countries until the possibility of default became clear.

The OMT program, which allows the ECB to buy sovereign bonds of countries that have agreed to reform their economies, significantly levels the playing field between the Bank and its advanced economy peers.

So, although dollar bonds and, increasingly, dollar equities are a large part of these countries sovereign wealth accounts, most of the dollar securities that they hold are not needed to finance trade imbalances.

Prior to its 2005 sovereign debt exchange, its legislature enacted a lock law, which barred the way to any future offers to holders of bonds on which Argentina defaulted in 2002.

Prices of bank shares and the Euribor OIS spread (a measure of financial stress) signal a profound lack of confidence in the sovereign debt of distressed countries, with yields on ten year Greek bonds recently hitting 25 .

The ECB has promised to buy Italian and Spanish sovereign bonds to keep their interest rates down, provided these countries ask for lines of credit from the European Stability Mechanism and adhere to agreed fiscal reforms.

The dilemma is that, whereas fiscal consolidation is necessary to prevent an unsustainable increase in the spread on sovereign bonds, the short run effects of raising taxes and cutting government spending tend to be contractionary.

Similarly, with its outright monetary transaction (OMT) program, the European Central Bank has offered to buy peripheral eurozone countries sovereign bonds in the secondary market provided that they sign up to agreed reforms.

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Bond lending involves diversified groups of bond holders, including domestic residents, and can be issued under different jurisdictions.

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But the literature on related instruments known as collective action clauses suggests that borrowing costs would rise only for governments approaching the limit of their creditworthiness that is, close to the cocos trigger.

The new bonds, other than those governed by Argentine law, will include Collective Action Clauses (CACs).

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The healing process is also evident in Europe, though, unfortunately, it is effectively limited only to sovereign bond markets. The real economy remains under enormous pressure in several countries, as economies contract and unemployment remains alarmingly high.

Because of the difficulty of putting banks through a bankruptcy like procedure, there is an incentive, like that which arises in the context of sovereign debt, to postpone the painful process of imposing losses on bondholders and instead provide a bailout and hope for the best.

Without the ECB s willingness to buy a potentially unlimited volume of sovereign bonds to achieve its very imprecise objective of mitigating redenomination risk, the eurozone would have been doomed to recurring episodes of internal funding stress.

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