Sovereign debt restructuring: alternative solutions
The implementation of a multilateral mechanism for sovereign debt restructuring that the UN is calling for, is illusory. However, progress could be achieved in different ways: improving the contractual terms, introducing new clauses on automatic debt reprofiling and using the leverage of international funding.
By Christophe Destais
Post
In one year, the United Nations General Assembly adopted three resolutions aimed at creating a "multilateral framework" applicable to the restructuring of sovereign debt:
- Resolution 68/304 (September 10, 2014) “decides to elaborate [...] a multilateral legal framework for sovereign debt restructuring processes";
- Resolution 69/247 (December 29, 2014) created a special committee to develop this legal framework;
- Resolution 69/319 (September 10, 2015) “Declares that sovereign debt restructuring processes should be guided by the following Basic Principles […] A Sovereign State has the right, in the exercise of its discretion, to design its macroeconomic policy, including restructuring its sovereign debt, which should not be frustrated or impeded by any abusive measures. Restructuring should be done as the last resort and preserving at the outset creditors’ rights.”
These resolutions, which are not binding, were presented by South Africa on behalf of the G77 (a coalition of developing countries, designed to promote economic and political collective interests of its members and develop an increased negotiating capacity in the UN. The G77 currently counts 134 of the 193 countries who vote) and by China.
On September 7, a group of economists called on European countries to vote in favor of resolution 69/139 in the British newspaper The Guardian. This call, taken up in France by Le Monde, was not followed. Germany and the United Kingdom voted against the resolution and the other European countries abstained.
These initiatives come after the rejection in 2003 of a project the IMF launched in the wake of the 2001 Argentine debt default : the Sovereign Debt Restructuring Mechanism (SDRM). The SDRM was inspired by the bankruptcy procedures applicable to companies. It failed due to the impossibility of imposing forced completion on sovereign states, at least on their national territory, and political reluctance to create a new international mechanism.
The euro crisis sparked a renewed debate on the necessity to devise an international mechanism to manage sovereign debts restructuring but recent initiatives have mostly been driven by the decision of a US judge regarding the Argentine debt. At the request of vulture funds, judge Griesa blocked payments from the Argentine governments to creditors holding 92% of the initial debt - who accepted a drastic restructuring – till the remaining creditors – who had refused the debt restructuring- would not be repaid in full. This decision is considered by most observers as an abusive interpretation of the pari passu clause in the loan contracts which provides for an equitable treatment among creditors. It became definitive in 2014.
Nevertheless, the choice of developing and emerging countries to discuss this issue before the UN general assembly is ambiguous. First, the choice of the forum and the proliferation of resolutions tend to politicize a debate the technical dimension of which is complex. At the same time, this choice reflects the fact that these countries do not feel heard at the IMF. The very terms used by the resolutions lend to interpretations and controversies, especially the "right" recognized to each government to restructure its debt. Finally, this approach is "systemic" as was the IMF 2002 proposal and which led it to fail.
In addition the UN resolutions fail to include other possible pathways which do not provide a comprehensive and definitive answer to the problem but help improving the situation.
The first possibility is to introduce "collective action clauses (CAC)" in the debt contracts that are the support of international bond issues. Such provisions have been included in bonds issued by private companies under English law since the nineteenth century, but they were ignored by the US legal system and in particular by the law of the state of New York, under which most dollar bond issuances by developing countries took place. However, in 2003, after the failure of the proposed SDRM, CAC defining the qualified majority rules applicable in case of restructuring were introduced in sovereign bonds of emerging countries. Bradley and Gulati (2014) estimate that these clauses are now included in 90% of sovereign debt issuance under the law of the State of New York. The same study estimates that the introduction of CAC has had no impact on borrowing costs. The Treaty of 2012, which created the European Stability Mechanism, mandated the introduction of CACs in sovereign bonds in the euro area.
Recently, the IMF abandoned its ambitious 2002 project probably more by pragmatism than conviction. In a report published in May 2014, it advocated the strengthening of the contractual framework for bond issuances: changes in pari passu clauses to prevent a repeat of the Argentina scenario and the introduction of more stringent CACs. In August 2014, the International Capital Markets Association (ICMA) published with the support of the Fund, a new pari passu clause, that meets the criteria set by the IMF, and a revised version of its CAC standard for sovereign bonds . The changes that will result from this initiative, however, may be "partial and fragmented" insofar as past experiences suggest that if markets refer to ICMA standard clauses, the latter are seldom transposed literally (Gelpern 2014). Furthermore, these provisions are not retroactive; it will take years, even decades, for the stock of sovereign debt to be affected by these changes.
A third way that appears promising would be to introduce sovereign debt restructuring arrangements in the initial contracts. The concept was implemented in the German debt restructuring agreement of 1953: payments were conditioned to the fact that Germany generates a trade surplus and were limited to 3% of export earnings; part of the repayments was only due after reunification - hypothetical at the time - or after the integration to Germany of former Prussian territories that are now in Poland and Russia. Submitting debt repayments to certain conditions is possible if and only if these conditions are phrased very clearly that their eventual realization is easily verifiable. To date, this idea has not been implemented at the stage of initial debt issuance but some of its principles were implemented in the form of warrants attached to the new bonds issued in the framework of the Greek and Argentine debt restructuring. A joint study by the Bank of England and the Bank of Canada (Brooke et al. 2013) recommends that large issuers, such as Canada and the UK, would recourse to it and its possible implementation was mentioned for the Greek debt.
A fourth way is to use international funding, including from the IMF, as a lever: a restructuring of debt held by private investors would be required prior to the mobilization of international funding. The current process in Ukraine is following this path. Nevertheless, this lever is not universal. It does not apply to internal debt and the financial capacity of the IMF or other international or regional funding schemes is limited.
References:
Bradley (Michael) and Mitu Gulati “Collective Action Clauses for the Eurozone” Review of Finance, Volume 18 Issue 6 October 2014, Oxford University Press.
Brooke, Martin, Rhys Mendes, Alex Pienkowski and Eric Santor. 2013. “Sovereign Default and StateContingent Debt.” Bank of Canada Discussion Paper 2013-3.
Gelpern (Anna) “A Sensible Step to Mitigate Sovereign Bond Dysfunction”, RealTime Economic Issues Watch, The Peterson Institute for International Economics, August 29th, 2014
On September 7, a group of economists called on European countries to vote in favor of resolution 69/139 in the British newspaper The Guardian. This call, taken up in France by Le Monde, was not followed. Germany and the United Kingdom voted against the resolution and the other European countries abstained.
These initiatives come after the rejection in 2003 of a project the IMF launched in the wake of the 2001 Argentine debt default : the Sovereign Debt Restructuring Mechanism (SDRM). The SDRM was inspired by the bankruptcy procedures applicable to companies. It failed due to the impossibility of imposing forced completion on sovereign states, at least on their national territory, and political reluctance to create a new international mechanism.
The euro crisis sparked a renewed debate on the necessity to devise an international mechanism to manage sovereign debts restructuring but recent initiatives have mostly been driven by the decision of a US judge regarding the Argentine debt. At the request of vulture funds, judge Griesa blocked payments from the Argentine governments to creditors holding 92% of the initial debt - who accepted a drastic restructuring – till the remaining creditors – who had refused the debt restructuring- would not be repaid in full. This decision is considered by most observers as an abusive interpretation of the pari passu clause in the loan contracts which provides for an equitable treatment among creditors. It became definitive in 2014.
Nevertheless, the choice of developing and emerging countries to discuss this issue before the UN general assembly is ambiguous. First, the choice of the forum and the proliferation of resolutions tend to politicize a debate the technical dimension of which is complex. At the same time, this choice reflects the fact that these countries do not feel heard at the IMF. The very terms used by the resolutions lend to interpretations and controversies, especially the "right" recognized to each government to restructure its debt. Finally, this approach is "systemic" as was the IMF 2002 proposal and which led it to fail.
In addition the UN resolutions fail to include other possible pathways which do not provide a comprehensive and definitive answer to the problem but help improving the situation.
The first possibility is to introduce "collective action clauses (CAC)" in the debt contracts that are the support of international bond issues. Such provisions have been included in bonds issued by private companies under English law since the nineteenth century, but they were ignored by the US legal system and in particular by the law of the state of New York, under which most dollar bond issuances by developing countries took place. However, in 2003, after the failure of the proposed SDRM, CAC defining the qualified majority rules applicable in case of restructuring were introduced in sovereign bonds of emerging countries. Bradley and Gulati (2014) estimate that these clauses are now included in 90% of sovereign debt issuance under the law of the State of New York. The same study estimates that the introduction of CAC has had no impact on borrowing costs. The Treaty of 2012, which created the European Stability Mechanism, mandated the introduction of CACs in sovereign bonds in the euro area.
Recently, the IMF abandoned its ambitious 2002 project probably more by pragmatism than conviction. In a report published in May 2014, it advocated the strengthening of the contractual framework for bond issuances: changes in pari passu clauses to prevent a repeat of the Argentina scenario and the introduction of more stringent CACs. In August 2014, the International Capital Markets Association (ICMA) published with the support of the Fund, a new pari passu clause, that meets the criteria set by the IMF, and a revised version of its CAC standard for sovereign bonds . The changes that will result from this initiative, however, may be "partial and fragmented" insofar as past experiences suggest that if markets refer to ICMA standard clauses, the latter are seldom transposed literally (Gelpern 2014). Furthermore, these provisions are not retroactive; it will take years, even decades, for the stock of sovereign debt to be affected by these changes.
A third way that appears promising would be to introduce sovereign debt restructuring arrangements in the initial contracts. The concept was implemented in the German debt restructuring agreement of 1953: payments were conditioned to the fact that Germany generates a trade surplus and were limited to 3% of export earnings; part of the repayments was only due after reunification - hypothetical at the time - or after the integration to Germany of former Prussian territories that are now in Poland and Russia. Submitting debt repayments to certain conditions is possible if and only if these conditions are phrased very clearly that their eventual realization is easily verifiable. To date, this idea has not been implemented at the stage of initial debt issuance but some of its principles were implemented in the form of warrants attached to the new bonds issued in the framework of the Greek and Argentine debt restructuring. A joint study by the Bank of England and the Bank of Canada (Brooke et al. 2013) recommends that large issuers, such as Canada and the UK, would recourse to it and its possible implementation was mentioned for the Greek debt.
A fourth way is to use international funding, including from the IMF, as a lever: a restructuring of debt held by private investors would be required prior to the mobilization of international funding. The current process in Ukraine is following this path. Nevertheless, this lever is not universal. It does not apply to internal debt and the financial capacity of the IMF or other international or regional funding schemes is limited.
References:
Bradley (Michael) and Mitu Gulati “Collective Action Clauses for the Eurozone” Review of Finance, Volume 18 Issue 6 October 2014, Oxford University Press.
Brooke, Martin, Rhys Mendes, Alex Pienkowski and Eric Santor. 2013. “Sovereign Default and StateContingent Debt.” Bank of Canada Discussion Paper 2013-3.
Gelpern (Anna) “A Sensible Step to Mitigate Sovereign Bond Dysfunction”, RealTime Economic Issues Watch, The Peterson Institute for International Economics, August 29th, 2014
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