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Sovereign Debt Restructuring Old Debates, New Challenges James A CIGI PAPERS NO. 32 — MAY 2014 SOVEREIGN DEBT RESTRUCTURING OLD DEBATES, NEW CHALLENGES JAMES A. HALEY SOVEREIGN DEBT RESTRUCTURING: OLD DEBATES, NEW CHALLENGES James A. Haley Copyright © 2014 by the Centre for International Governance Innovation The opinions expressed in this publication are those of the author and do not necessarily reflect the views of the Centre for International Governance Innovation or its Operating Board of Directors or International Board of Governors or the United Nations University. This work is licensed under a Creative Commons Attribution — Non-commercial — No Derivatives License. To view this license, visit (www.creativecommons.org/ licenses/by-nc-nd/3.0/). For re-use or distribution, please include this copyright notice. 57 Erb Street West Waterloo, Ontario N2L 6C2 Canada tel +1 519 885 2444 fax +1 519 885 5450 www.cigionline.org TABLE OF CONTENTS 4 About the Author 4 Acknowledgements 4 Acronyms 5 Executive Summary 5 Introduction 6 Coordination Costs and Policy Responses 6 The Problem of Deadweight Costs 7 Creditor Coordination Problems 7 Incentives for Renegotiation 8 Policy Responses 8 Access Limits 9 Framework for Structured Bargaining 9 Stays on Litigation 10 DIP Financing 10 Cram Down Provisions 11 Debt Discharge 11 Old Debates 13 New Challenges 15 Recommendations 15 Limiting Asset Seizures and Creditor Runs, and Preserving Asset Values 15 Tax, Accounting and Financial Regulatory Frameworks 16 Facilitating Discussions on NPV Reductions 16 Conclusion 18 Works Cited 20 About CIGI 20 CIGI Masthead CIGI PAPERS NO. 32 — May 2014 ACRONYMS ABOUT THE AUTHOR CACs collective action clauses DIP debtor-in-possession ECB European Central Bank FfDO UN Financing for Development Office IIF Institute of International Finance IMF International Monetary Fund NPV net present value OMT Outright Monetary Transactions James A. Haley is the executive director for Canada, Inter-American Development Bank, SDF Sovereign Debt Forum Washington, DC, and the former director of the Global Economy Program at the Centre for SDRM Sovereign Debt Restructuring Mechanism International Governance Innovation. ACKNOWLEDGEMENTS Helpful discussions with or comments from Ed Bartholomew, Anna Gelpern, Domenico Lombardi, David Kempthorne, Andrew Powell and two anonymous referees are gratefully acknowledged. Of course, they are not responsible for any remaining errors, which are the sole responsibility of the author. The author also gratefully recognizes a productive and stimulating collaboration with Benu Schneider of the United Nations Financing for Development Office (FfDO); this paper draws on a series of Experts’ Group meetings and panel discussions organized jointly by the Centre for International Governance Innovation and the FfDO (see FfDO and CIGI 2012; FfDO, CIGI and Commonwealth Secretariat 2012). The views expressed are strictly those of the author and do not necessarily reflect those of the board or the management of the Inter-American Development Bank or the Government of Canada. 4 • CENTRE FOR INTERNATIONAL GOVERNANCE INNOVATION SOVEREIGN DEBT RESTRUCTURING: OLD DEBates, NEW CHALLENGES EXECUTIVE SUMMARY INTRODUCTION Ten years ago, in the wake of the Asian financial crisis After a long hiatus, the Greek debt crisis and ongoing and subsequent Argentine default, the international litigation against Argentina have reanimated the debate community debated how to best promote the timely, on sovereign debt restructuring that raged a decade or effective restructuring of sovereign debt. The debate then more ago. Two years after the Greek restructuring, doubts focused largely on the relative merits of a so-called statutory remain about the sustainability of the adjustment effort approach for sovereign restructurings, with features of required under the terms of the international support domestic bankruptcy regimes, versus the voluntary use of package, fuelling concerns that a further restructuring contractual terms designed to facilitate restructurings. At will be required. At the same time, Argentina’s long- the time, the statutory approach did not have the support standing legal dispute with “hold-out” investors who necessary to move from proposal to policy and efforts to did not participate in past debt restructurings, which led improve the framework of sovereign debt restructuring to a judgment against it, may, it is feared, undermine the rested on the contractual approach. process of voluntary or market-based restructurings that has developed over the past two decades If Argentina is Today, the issue of sovereign debt restructuring is again unsuccessful in its appeal to the US Supreme Court, such on the international policy agenda and the debate is once restructurings could be more difficult to secure, since the more framed in terms of statutory versus contractual expected returns from holding out would be increased. approaches. This paper is intended as a guide to the issues. It first reviews the underlying problems that impede timely The issue of sovereign debt restructuring had fallen off the sovereign debt restructurings and the tools that have been international policy agenda a decade ago, as concerns of developed to address them. It then identifies the policy a systemic threat to the global financial system dissipated responses that were proposed and discussed a decade in the benign conditions that prevailed before the global ago in response to the financial crises that were sweeping financial and economic crisis. In this respect, the so-called through the global economy. Some elements of these “old “Great Moderation” may have lulled markets and policy debates” have declined in importance given developments makers into complacency about the risks of a new wave of over the past decade. Other elements of those earlier sovereign debt crises and, absent the discipline of financial discussions, however, remain relevant in the context markets, allowed excessive accumulation of private sector of the “new challenges” that confront the international debts. Once the crisis struck, however, bank failures led to community, which include concerns regarding the the transfer of debt burdens from private to public sector sustainability of Greece’s debt in an environment of balance sheets, while fiscal deficits widened everywhere possible deflation and the potential effects that ongoing as economies weakened. litigation against Argentina could have on the current framework for sovereign debt restructuring. This confluence of factors leading to higher debt burdens and increased risks of sovereign debt difficulties is not unique. As was the case a decade ago, the statutory approach The seminal work of Carmen Reinhart and Kenneth Rogoff likely lacks the support needed for implementation. (2009) documents a pattern of asset and real estate bubbles Nevertheless, efforts to enhance the framework for and excessive debt accumulation. Viewed through this sovereign debt restructuring should continue, given long-term perspective, the series of international financial the large adjustment challenges that still cloud global crises that motivated international efforts to reform the economic prospects five years after the trough of the international financial architecture a decade ago are, like worst worldwide downturn since the Great Depression. the global financial crisis, simply additional observations This paper suggests three areas for further analysis. The in a long history of debt and default. Moreover, this history first is expanding the scope of contractual clauses that can underscores the importance of improving the framework help facilitate restructurings. The second is accounting, for sovereign debt restructuring. tax and regulatory frameworks; the goal would be to identify possible changes that would remove obstacles Ten years ago, debate on this issue was marked by to timely, orderly restructurings. Improving the process a cleavage between those prepared to support so- by which debt restructuring negotiations are conducted called “voluntary” approaches, in which bondholders is the final area in which efforts can be made to improve would accept contractual modifications that facilitated the restructuring process. A voluntary Sovereign Debt restructuring, and those who supported the more formal, Forum (SDF) that promotes the exchange of information statutory approach represented by the Sovereign Debt and provides a repository for best practice could accelerate Restructuring Mechanism (SDRM) — as developed by negotiations, leading to earlier access to private markets the International Monetary Fund (IMF) under then First and a return to growth. Deputy Managing Director Anne Krueger. Policy makers decided to abandon statutory approaches in the wake of concerted efforts to include collective action clauses (CACs) in new bond issues of key emerging market JAMES A. HALEY • 5 CIGI PAPERS NO. 32 — May 2014 economies. Such clauses have since become part of the de the problem of illiquidity to include the issue of insolvency facto “boilerplate” of bonds issued under New York law.1 and the debt writedowns that default may entail. In part, this shift in emphasis reflected the fact that expectations In some respects, current discussions on restructuring of medium-term growth for some countries were revised sovereign debt mirror that earlier debate. Then, as now, down, impairing debt-servicing capacity; in part, because attention focused on the relative merits of constructing a some governments assumed private sector debts during formal legal framework
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