Sovereign Debt Restructuring

Sovereign debt restructuring Benu Schneider The views expressed do not necessarily represent those of the Financing for Development Office, Department of Economic and Social Affairs, UN Restructuring options by compositon of debt Debt to official Debt to commercial Debt to Multilaterals Bond debt creditors Banks Yes, with and No, it cannot be Yes, London Club without collective restructured except Yes, at the Paris Club action clauses for HIPC countries The terms of treatment e.g. Pakistan are determined on Ukraine the basis of per capita Ecuador and debt ratios Belize (require bilateral agreements after Paris Club agreements) Covers only PC members Implications of the Argentine Debt Litigation • Consensus that this is game changer – will impact future debt restructurings by strengthening the hands of holdout creditors – illustrates the legal gaps in architecture • Support improvement in contractual technology but something else is needed in addition – moreover there is still the problem of the existing debt stock + voluntarity Diversity in debt restructurings • Those without nominal haircuts move rapidly, fewer holdouts, but need multiple restructurings. Costly in the long run for both debtors and creditors. For deeper “haircuts” negotiations are protracted. • There have been a substantial number of “voluntary” restructurings, as the fall-back position has been protracted legal processes characterized by uncertainty. • Deeper haircuts - creditor cajoling, Growth and defaults • Default and restructuring appears to be negative for debt and positive for growth. • There is always a massive reduction in growth before a default. Is this inevitable? • Could be Pareto improving if we could design a debt restructuring system that minimized that deep decline in growth before default Litigation in sovereign debt defaults is more common than the general perception • In recent times 50% of debt crises involved legal disputes affecting 25 countries(data base covers US and UK). • Increasing strength of holdout creditors - Argentine case is part of a general trend • Distressed debt funds involved in 75 % of cases Shumacher, Trebesch anf Enderline “Sovereign Defaults in Court” (May 2014) Costs of sovereign debt restructurings Output losses Around 5 per cent a year, Up to 10 years. Higher if twin or triple crises Trade losses Falls bilaterally by about 7 percent per year, average 15 years Decreased access to Drop in private sector access of up to 40 per external credit cent in the year after Higher spreads Greater haircuts = larger post-restructuring bond spreads until 6-7 years after Also highly correlated with duration of capital market exclusion Financial instability Loss of value of restructured assets, deposit withdrawals and interruption of interbank credit lines, interest rate hikes Lower FDI Drop in flows of up to 2% of GDP per year Lower credit ratings After 1 year most sovereign bonds: C- rating IMF 2012, Sovereign debt restructurings 1950-2010: Literature survey, data and stylized facts Reasons for lack of consensus between official and private sector • Different indicators to gauge the success of a debt restructuring • The private sector measures success by percentage of bondholders who participated in the debt restructuring • How quickly the debt restructuring is completed • How well the instruments perform after a debt restructuring – they cite 80 – 90 percent participation as success Official sector criteria • The costs to the local economy of debt restructuring • The residual debt burden which in many restructuring is even higher than before • How fast the country can return to a sustainable debt and growth trajectory. Delay: Different criteria between official and private sector • For the private sector delay means once the process is initiated, how long it takes reach a settlement in the negotiation • For the official sector “delay” has two parts »Delay in initiating a debt restructuring »Once initiated, the time it takes to reach a settlement • Delay gives vulture funds the opportunity to purchase debt at a discount and then holdout for high gains • In the next EGM, participants are ready to work collectively to find solutions Meet the gap in architecture The IMF plays a unique role in assisting its members to strike a judicious balance between financing and adjustment but it runs the risk of being less effective in this role due to the absence of a framework for timely and orderly debt restructuring Moral hazard of IMF lending to both debtors and creditors • Debtors defer needed adjustments hoping for an improvement in economic conditions • Lenders do not correctly price in risk • Banks may postpone recognizing losses on their balance sheets Lending into arrears • 1998: good faith negotiation • 1999: good faith effort to reach a collaborative agreement with its creditors • 2002: good faith criterion elaborated into a full-blown set of prescriptions and procedures Gave grounds for intense lobbying by the private sector (but nothing in its arsenal over jurisdiction over private sector) IMF arbiter and referee of good behaviour and good faith • After Asian fin crisis – policy of exceptional access (post Greece, amendment of policy) Lack of a credible exit strategy Sometimes the lack of an acceptable alternative in terms of an orderly exit gives the IMF little choice but to exercise forbearance and continue disbursements even in cases where, on the balance of probabilities, an inter- temporal solvency condition may be violated. Costs of non-system The current implied costs of debt restructuring provide incentives for debtors to gamble that recovery will allow them to avoid a debt treatment ---private-sector debt is effectively shifted to more senior public creditors, thereby implying an increase in the size of any haircut that must eventually be imposed on remaining private-sector creditors. Options going forward • An improvement in the contractual technology to improve the voluntary market-based approach • A statutory solution to address holdouts by minimizing litigation risks in the Eurozone • A regime incorporating both the voluntary contractual and statutory approach • A statutory regime • An informal platform for creditor-debtor exchanges A. Improving contractual technology • Aggregation in bond contracts • Standardising pari passu clause • Standstills • Process questions in creditor coordination – consultative vs. creditor committees Why standstills? • It prioritizes financial stability • Prevents cross-border default and acceleration • Brings creditors together • Gives the official sector time to find a solution. Statutory approach • The IMF’s capacity under Article VIII, 2(b) to temporarily approve restrictions on current payments (that is to say, interest payments) could result in partial stays on creditor actions on arrears. • For other arrears relating to capital payments (for example, non- payment of bullet payments of principal), an amendment of the IMF Articles of Agreement would be required to achieve symmetry between the treatment of arrears arising from capital and those from current payments. Need to resolve possible conflict of interest in the IMF’s role of arbiter and creditor. Contractual approach to Standstills • Standstills in bond contracts to set out the contractual terms for non-payment of interest and suspension of payments. • Presently it is typical to have a grace period of three to13 days, for resolution of any technical difficulties in making payments only • Although consent for new financing could be obtained through trustee relationships or collective action management, trustees don’t like discretion, and thus clearer rules are needed. Moreover, timing issues would also have to be overcome, since notice of 21 days is required to call a meeting of creditor committees. Sovereign Cocos • Bonds that would extend in repayment maturity when a country receives official sector liquidity assistance. • Addresses liquidity crisis, gives country breathing space to assess whether it is in a liquidity crisis or a solvency crisis Can clearer rules of the game help to remove the impediments to an early initiation of debt restructurings? Process issues: •Ex-ante structures for creditor committees with a governance and oversight body Or •Consultancy approach through a legal advisory and informal soundings with creditors EX-Ante Structures for Creditor Committees Ex-ante structures for creditor committees, with pre-defined rules with a governance structure and oversight body Verification of fin data and eco assumptions, Soundings, Single negotiation, stress testing, endorsement, creditor coordination B. Statutory solution for litigation risks in the Eurozone • ESM Treaty could be amended so that the assets of a sovereign located within the Eurozone would be immunized from attachment by those creditors not participating in any such sovereign’s debt restructuring where that sovereign was benefitting from a financial assistance program from the ESM. C. Combing the voluntary and statutory approach • Creating the shadow of the court house in voluntary debt restructuring A version of the dispute settlement mechanism of the WTO IMF structure convening power A system in which there are panels of experts (not IMF staff) Combining voluntary and statutory approaches (contd..) STAGE 1: Negotiations are voluntary but with a deadline. Stage 2: If no agreement is reached, the second stage could be a panel, which serves as an arbiter. Stage 3: And finally, if that doesn’t work, a panel can settle the dispute which is binding

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