Sovereign debt work-out arrangements

Developed, developing countries and the international financial institutions (IFIs) recognise the need for adequate mechanisms to resolve situations of sovereign insolvency. At the moment, there are no arrangements for sovereign debt work-outs. The possibility of a debt work-out mechanism would allow countries and its creditors to renegotiate debt in an early stage of a financial crisis. This will decrease chances for escalation of financial turbulence in a country or contagion to other economies.

Despite the recognition of the need for an international sovereign debt work-out mechanism, there is no agreement on how such a mechanism should be constructed. The IMF has proposed to create a forum under its supervision, in which an insolvent country can renegotiate debt with a qualified majority of its creditors. Once the debt is renegotiated, then the restructuring process has to be accepted by all creditors. The proposal necessitates amendments in the statutes of the IMF and is an example of the statutory approach. (For an explanation of the statutory approach visit the research section). This IMF proposal, the so-called Sovereign Debt Restructuring Mechanism (SDRM) is, among others, criticised for:

• The influence and power that the IMF will get through the SDRM.
• The potential negative impact on the borrowing costs for developing countries and the volume of capital flows to these countries
• Being yet unclear as to which types of debt fall under the proposal; the IMF has indicated that loans falling under domestic law such as those from the IFIs and official bilateral sources will be excluded from the SDRM
• Its expected time-consuming character.

The United States is an important opponent to the SDRM. Representatives of the US Treasury have come with an alternative solution through so-called Collective Action Clauses (CACs). The inclusion of CACs in international bonds will allow binding decision-making among a majority of creditors and limit harmful behaviour of a dissident creditors’ minority. CACs are an example of the contractual approach; they are a market-based mechanism. (For an explanation of the contractual approach visit the research section). The G10 countries have been drafting sets of model clauses. Critique on this contractual approach is that:

• Not all debt is covered by bonds
• The inclusion of CACs in bonds, which are to be concluded, does not offer a solution for bonds that have already been issued.

The concept of the IMF’s SDRM and the CACs are considered to be each other’s opposites, but are not mutually exclusive. There are several other proposals that contain aspects from one proposal or from both.

Important proposals for supportive means in addition to either the SDRM or the CACs is the plan which the private sector and the French Central Bank (the “Trichet Proposal”) have suggested, i.e. to introduce concepts for Codes of Conduct. The plans include a framework for general principles which official and private creditors as well as debtors can apply. Examples of principles are: a fair representation of creditors on existing or agreed modalities, fair burden sharing between debtor and its creditors, and early engagement with creditors when debt problems arise. (See e.g. Kaiser, 2003).

The position of EU member states and the European Union

The issue of sovereign debt work-out arrangements mainly falls under the responsibility of the EU’s member states’ Finance Ministers and/or their Central Bank Governors. The member states agree on the inclusion of CACs in international bonds. In September 2002 the Finance Ministers decided to push for the inclusion of CACs in their bonds which are issued abroad. Contrary to this agreement on CACs, the EU member states do not share a common position towards the SDRM; support from the member states ranges from rejection to active support. The United Kingdom appreciates certain ideas of the SDRM but believes that CACs will be more effective. Countries like the Netherlands, Belgium and Austria recognise the potential of the SDRM but emphasise that the concept needs to be developed further. Germany, the Scandinavian countries and France seem to appreciate the IMF proposal most. They regret that the international community has not been able to reach consensus on the issue.

At the EU level involvement has been limited. The European Central Bank does not seem to involve itself in the discussions. The European Commission however has been passively contributing to the discussion, for example through participation in the meetings of the IMF. During the 2003 Spring Meetings of the IMF, the European Commission underlined the need to further develop the IMF proposal of the SDRM, although it seems more supportive towards the inclusion of CACs, at least for the moment. The French proposal is in the eyes of the Commission a welcome suggestion as a additional means to the SDRM and CACs.

The position of developing countries

Developing countries have reservations about both the SDRM proposal and the CACs. Regarding the SDRM, they fear that the mechanism will increase the costs of borrowing. Another objection is that if a mechanism is agreed within the IMF, developing countries do not have sufficient voting power to influence the characteristics of the instruments. They feel this is unfair, since the developing countries are those which will be most affected by the SDRM.

A problem with the CACs is the fact that they can only be applied in bonds and do not cover other kinds of debt. However, developing countries are more inclined towards CACs than towards the SDRM. This relatively positive attitude towards CACs relates to the successful issuance of Mexican bonds under New York legislation in February 2003. Mexico was the first large emerging market which announced the inclusion of CACs at the issuance of the bonds. (See Press release, Mexican Ministry of Finance).

Mexico is an important opponent to the SDRM together with countries such as Brazil and Argentina. Other emerging markets share their concerns on the SDRM proposal. Some developing countries believe that despite the shortcomings of the SDRM, the proposal is worth developing further. (See e.g. G24, 2003). In addition, other non-statutory approaches need to be explored as well. The G24 seem to prefer these kind of voluntary approaches which are market friendly and country specific.

Important developing countries such as India and China seem to take a neutral position in the discussions on debt work-out mechanisms.

Further details

G7 Action Plan Implementation, G7, April 2003

This plan of action was issued after the G7 meeting of Finance Ministers and Central Bank Governors held in April 2003, when the Ministers gathered for the IMF/World Bank Spring Meetings. The G7 Action Plan pays attention to the different proposals regarding sovereign debt restructuring. The proposal of Codes of Conducts will be examined further in a report (completion Fall 2003). The concept of CACs need to be further promoted. The SDRM proposal is in the opinion of the Ministers not feasible at this moment. Continued effects for further development are most welcome, however.

For the document click here.

G-24 Secretariat Briefing Paper On Sovereign Debt Restructuring, G24, 2003

In this briefing paper the G-24 recapitulate their position towards CACs and the SDRM. They indicate their preferences for a voluntary, market based approach towards solving problems of sovereign debt. They also emphasise the shortcomings of the SDRM.

For the document click here.

Towards a Code of Good Conduct for Enhanced Prevention and Resolution of International Financial Crises, Banque of France, 2003

This two-page editorial of the French Central Bank’s Monthly Digest describes the introduction of Code of Good Conduct, as was suggested by Jean Claude Trichet, Central Bank Governor.

For the document click here.

12-Year Global UMS Bond with Collective Action Clauses Issued in the International Markets, Ministry of Finance – Mexico, Press release 26 February, 2003

This press release sets out the aspects of the bond issuance in which the Mexican government included CACs.

For the document click here.

Report of the Group of Ten Working Group on Contractual Clauses, G10, IMF/BIS/OECD, 2002

This document reviews the potential role of CACs in addressing debt problems of countries. 

For the document click here.

Sovereign debt restructuring: A U.S. perspective, Taylor, J.B., Under Secretary of Treasury for International Affairs, Remarks made at the conference “Sovereign Debt Workouts: Hopes and Hazards? Institute for International Economics, Washington, 2002 

In this speech, the US Under Secretary of Treasury gives an outline of his ideas on debt restructuring mechanisms, setting out an alternative approach for debt work-out arrangements: the collective action clauses. Taylor builds on earlier proposals of contractual approaches to debt restructuring (See e.g. Rogoff and Zettelmeyer, 2002)

For the document click here.