Gaps in the Architecture for 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 Identifying Gaps in the IMF Architecture for Debt Resolution in a world of open capital accounts New Financing Standstills Adjustment IMF Debtor-in-Possession Financing by the Private Sector Article VII 2b for Current Transfers Provision for Standstills for Capital Accounts Transfers Domestic Policies + adjustment thru exchange rate Adjustment through Debt-Restructuring Lack of a rules-based platform for engagement of debtors and creditors, creditor coordination, independent DSAs, Debt Restructuring and No formal platform for the engagement between the private and public sector 1
Fragmentation Debt to Multilaterals Debt to official creditors Debt to commercial Banks Bond debt No, it cannot be restructured except for HIPC countries Yes, at the Paris Club The terms of treatment are determined on the basis of per capita and debt ratios (require bilateral agreements after Paris Club agreements) Covers only PC members Yes, London Club Yes, with and without collective action clauses What would the SDRM1 have done? Creditor committees / Voting thresholds Priority financing Restructuring agreement Sovereign debt dispute resolution forum Type of debt to be treated, verification, comprehensiveness Stays by majority rule Sanctions 2
Gaps in architecture Lack of a centralized dispute resolution mechanism Lack of organized representation of all stakeholders Lack of enforceable priority rules for creditors Problems with inter-creditor equity and equity between the private and public sector No international law governing international bankruptcies judgments passed in one jurisdiction is not enforceable in another jurisdiction legal diff across jurisdictions No provisions for standstills that provide breathing space. Independent DSAs Legal gaps Vulture fund litigation Concerns Creditors Debtors Erosion of creditor rights Willingness to pay potentially capricious behavior by some debtors Impacted by preferred creditor status Non-system implications for global financial stability Undue lags Insufficient debt relief leading to future debt restructurings Jeopardy to resumption of growth and debt sustainability, impact on trade, FDI etc. Hold outs, litigation Access to finance and the cost of finance 3
Contractual discussion a step forward but only on bonds missing other loan contracts To be recognized that efficacy of CACs is limited Contractual terms cannot take on the role of public policy such as externalities, societal distribution problems and broad equity terms for stakeholders Market based approach needs further work on process questions, standstills, safety clauses Aggregation Problem of existing stock Voluntary even after years may not have bonds issued with the new clauses Underlying assumption that no single investor has the scale of resources to block a restructuring plan but easy for example in the case of bonds issued by frontier markets or when some hedge funds form a single firm to prevent a restruct. plan 4
Jurisdiction issues Judgment passed in one jurisdiction are not enforceable in other jurisdictions Lack of coordination between different courts and the WB s ICSID All litigation cannot be settled under one umbrella, ensure inter-creditor equity The lack of coordination has high human and financial costs for debtors They result in delay high costs- lack of access to markets 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) 5
Creditor returns high in litigation cases Lack of systematic work but in the past known to be high 400 % for Elliot in Peru Elliot 60 % in Panama Cardinal Financial Inv. 270 % in Yemen Litigation is associated with a)loss of market access b)loss in int. trade c) delays in crisis resolution Externalities larger than the amounts under litigation 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 6
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. A large no. of voluntary and light restructurings, as the fall-back position has been protracted legal processes characterized by uncertainty. Deeper haircuts - creditor cajoling, Costs of sovereign debt restructurings Output losses Trade losses Decreased access to external credit Higher spreads Financial instability Lower FDI Lower credit ratings Around 5 per cent a year, Up to 10 years. Higher if twin or triple crises Falls bilaterally by about 7 percent per year, average 15 years Drop in private sector access of up to 40 per cent in the year after Greater haircuts = larger post-restructuring bond spreads until 6-7 years after Also highly correlated with duration of capital market exclusion Loss of value of restructured assets, deposit withdrawals and interruption of interbank credit lines, interest rate hikes Drop in flows of up to 2% of GDP per year After 1 year most sovereign bonds: C- rating IMF 2012, Sovereign debt restructurings 1950-2010: Literature survey, data and stylized facts 7
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 8
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 9
Evolution of policy of lending into arrears 1970: intolerant of arrears (arising due to foreign exchange restrictions) restructuring considered harmful arrears to be eliminated during the duration of the fund program 1980:relaxation of the requirement that the arrears had to be cleared during the duration of a funds program Possible need for elimination of arrears thru debt renegotiation (but not how) 1980s Debt Crisis IMF - three principles protect its own resources became an advocate of burden sharing IMF s preferred creditor status IMF did not lend money till arrears with private creditors were cleared either thru rescheduling or new money or both (forced debtors to agree terms set by private creditors) no arrears policy put the IMF at risk not to lend at all 10
Lending into arrears (contd) 1989: arrears policy modified to tolerate temp arrears to commercial banks even if no agreement on debt renegotiation had been reached (no tolerance of arrears to PC creditors who were 60.67 percent of IMF ex board) 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) 11
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 intertemporal solvency condition may be violated. 12