EU-LDC Themes - International Capital Markets - Research
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International Financial Architecture: Sovereign debt work-out
arrangements
Background
Relevant
publications
Links
Background
Discussions on sovereign
insolvency date back to the early 1980s when policy makers from
developing countries and academics presented proposals to deal with
debt problems of sovereign countries. There were calls for debt
work-out mechanisms which would allow the restructuring of sovereign
debt in case a country becomes insolvent. In most countries debt
restructuring procedures are common for corporate bankruptcies. Some
federal states also have debt work-out arrangements for local
entities such as municipalities. At the international level debt
work-out arrangements are still lacking. Until 2001, the IMF
resisted the proposals claiming that work-out arrangements might
lead to moral hazard among debtors and creditors. It believed that
with a debt work-out mechanism both debtors and creditors would have
no incentives to work-out insolvency problems as they can expect a
bail out from the IFIs.
However, in 2001 the IMF
changed its position and came up with a proposal to address
sovereign insolvency through a Structural Debt Restructuring
Mechanism (SDRM). There are several possible explanations for this
sudden change among IMF policy makers. There was a higher need for
new mechanisms in the International Financial Architecture (IFA)
after the crises in Argentina and Asia. Argentina and countries in
Asia received massive aid packages to cure the problems of the
crises. In the future the provision of such aid packages might
strain the Fund’s resources and its ability to act. With a debt
work-out mechanism the need for massive aid packages might be much
lower. The recent crises in Asia and Argentina furthermore triggered
a wave of criticism against the IMF for its failure in curing the
financial and economic problems in these countries in the aftermath
of the crises. As a result, the IMF needed to improve its reputation.
Other critics regard the IMF proposal as an attempt of the Fund to
secure its own position in the reform of the IFA.
The proposal of the IMF
as advocated by the Fund’s First Deputy Managing Director Ann
Krueger is based on Chapter 11 of the US Bankruptcy Code on
corporate insolvency. The proposal will allow debtors and creditors
to renegotiate debt under supervision of the IMF. According to the
proposal an institution within the IMF will arbitrate over the debts.
For implementing the IMF proposal it would be necessary to amend the
Articles of the IMF. Therefore, it is a statutory approach to
the issue of sovereign insolvency. Next to the statutory approach is
a contractual approach. The contractual approach also
identifies a role for an arbitration commission. However, the
establishment of an arbitrating institution does not necessitate a
change of the IMF Articles. Rather, it should be within the
contracts which creditors and sovereign debtors conclude. The
contractual approach ‘involves clauses in debt contracts that
encourage creditors and borrowing countries to undertake
negotiations aimed at an expeditious, but orderly, restructuring of
unsustainable sovereign debt.’ (Hubbard, 2002).
It is a market-based approach. The supporters of a contractual
approach believe that debt work-out mechanisms should serve to
improve the creditworthiness of insolvent countries allowing them to
attract capital from the private sector. One of the main proponents
of the contractual approach is John B. Taylor, Under Secretary for
International Affairs of the US Department of Treasury.
The proposals on debt
work-out arrangements which have been suggested over the past two
decades include several aspects of the statutory and/or the
contractual approach. The different proposals have generally two
aspects in common. First, there are arrangements which allow (almost)
insolvent countries to work-out solutions with their creditors.
Secondly, a majority of creditors will work-out a solution which is
applicable to all creditors. (Raffer and Springer, 1996). However,
there are differences between the proposals concerning the role of
the IMF in debt work-out mechanisms. The proposal of the IMF
advocates an important role for the Fund itself. Most opponents of
the IMF scheme argue that the IMF is in most cases a creditor itself
and is therefore not an independent party. An arbitration
institution which is led by the IMF will make the fund a judge in
its own cause.
Sources: The Foreign Aid
Business; economic assistance and development cooperation, Raffer,
K., Singer, H.W. (1996), Edward Elgar, Cheltenham. (Not available
on-line)
Relevant publications
This section provides a
selection of the literature on sovereign debt work-out arrangements.
The documents are organised as follows:
General
Bankruptcy Procedures
for Sovereigns: A History of Ideas 1976-2001,
Rogoff, K., Zettelmeyer, J., 2002, Working Paper 02/133, IMF,
Washington D.C.
This paper gives an
overview of the discussion on debt work-out arrangements and the
different proposals which have been made. The authors start in the
late 1970s prior to which it was not common for developing countries
to borrow intensively from official and private sources. The
authors focus on policy proposals including ideas of dealing with
sovereign insolvency through negotiation or arbitration. Among
others, the paper discusses proposals by Oechsli, Raffer,
Eichengreen, Krueger and Taylor. Most proposals suggest applying
some kind of domestic bankruptcy method to sovereign insolvency. The
authors expect that resulting from the discussions actual reform
will be reality in the near future.
For the document click here.
The Resolution of
International Financial Crises: Private Finance and Public Funds,
Haldane, A., Kruger, M., 2001, Bank of England/Bank of Canada,
London/Ottawa
This document is one of
the papers that contributed to the renewed discussion on debt
work-out mechanisms. The authors believe that recent initiatives
such as financial standards are important steps to prevent crises.
Nevertheless, there remains a need for better crisis resolution
mechanisms. The IMF massive aid packages imply several difficulties
including the possibility of moral hazard. Therefore, the authors
propose a framework for crisis resolution, which differs from other
proposals and existing mechanisms in the fact that it is a sequenced
and structured crisis resolution framework. It places a debt
work-out mechanism in the process of crisis resolution. The main
ingredients of the framework are: (1) limited multilateral official
aid; (2) stimulate private involvement, e.g. through voluntary debt
rollovers; (3) a temporary payments standstill; and (4) clear
procedures on possible exceptional multilateral official aid.
For the document click here.
International Monetary
Fund
The Design of the
Sovereign Debt Restructuring Mechanism – Further Considerations,
IMF, prepared by the Legal and Policy Development and Review
Departments, 27 November 2002
This paper has been
prepared in order to develop a concrete proposal on a statutory
sovereign debt work-out mechanism, which is reviewed during the
April 2003 meeting of the International Monetary and Financial
Committee (IMFC). The IMFC is the primary advisory body to the Board
of Governors of the IMF. The document includes information on how a
SDRM should work. It proposes a Sovereign Debt Dispute Resolution
Forum (SDDRF) which is supposed to serve as the arbitration panel in
case of debt restructuring.
For the document click here.
A New Approach To
Sovereign Debt Restructuring,
Krueger, A.O. 2002, IMF, Washington D.C.
This
publication is intended to present a summary of the IMF ideas on
debt work-out mechanisms as of April 2002. This was around six
months after Ann Krueger had presented the IMF proposal on the
issue. The document discusses the need for work-out arrangements,
the proposal of the IMF and its role in the process. The conclusion
summarises the IMF’s proposal. In the proposal the IMF Articles
need to be amended in order to have a qualified majority approve
restructuring and to force the approval upon all creditors. The
restructuring process can be based on corporate bankruptcy regimes.
The proposal has furthermore three key features: a standstill on
creditor litigation after suspension of payments; protection
mechanisms for creditors during the standstill; and the provision of
seniority for fresh financing by private creditors. A single body
needs to overview the process of debt work-out.
For
the document click here.
Statutory
versus contractual approach
Toward a Statutory
Approach to Sovereign Debt Restructuring: Lessons from Corporate
Bankruptcy Practice Around the World,
Bolton, P., 2003, Working paper WP/03/13, IMF, Washington D.C.
In this working paper
the author seeks to provide lessons from corporate bankruptcy codes
from the US and other countries. He finds four aspects of corporate
bankruptcy code which are common throughout the world and which
should be the foundation for sovereign debt work-out mechanisms. The
four aspects are (1) a stay on debt collection efforts, (2) broad
enforcement of absolute priority, (3) majority voting of creditors
and (4) priority financing during restructuring. The experiences of
corporate bankruptcy codes are relevant for a SDRM according to a
statutory approach. The author is in favour of the statutory
approach since in his opinion it will allow indebted countries to
file early. He identifies a role for the IMF. An IMF led statutory
approach will speed up the restructuring process, thus limiting the
harm of a potential economic crisis. The author stresses however
that the realisation of a SDRM will need to by complemented with
conventional IMF programmes. This is necessary for the economic
recovery of an insolvent country.
For the document click here.
Sovereign Debt
Restructuring: New Articles, New Contracts- or No Change?
Miller, M., 2002, in: International Economics Policy Briefs, April
2002, Institute for International Economics, Washington D.C.
In this article
Krueger’s (IMF) statutory approach is compared with Taylor’s (US
Treasury) contractual approach (see Introduction).
The authors discusses the history of debt restructuring and the need
to establish restructuring schemes at the international level. The
author finds that both approaches are complementary and can be
united into one approach. The process should start however with the
contractual approach and then followed by statutory changes since
the former are easier to implement quickly. Combining the two
approaches is better than developing one of the two approaches only.
For the document click here.
The Debt Crisis
Debate,
Debevoise, W., 2002, in: LatinFinance, November 2002
This is a short
contribution, focusing on the differences between the statutory
approach and the contractual approach. For the latter approach, the
author describes different examples on how to include clauses for
debt work-out arrangements in contracts. He pays some attention to
different opinions among the G-7 governments, the US treasury and
some associations such as the Emerging Markets Creditors Association
(EMCA). The author is in favour of a contractual approach over a
statutory approach under the SDRM, since the establishment of the
SDRM will take too much time before it can be effective. A
contractual approach may be much simpler.
For the document click here.
Enhancing
Sovereign Debt Restructuring,
Hubbard, R.G., 2002, remarks at Conference on the IMF’s Sovereign
Debt Proposal Amercian Enterprise Institute, 7 October 2002,
Washington D.C.
This short contribution sets out the
contractual approach in comparison with the statutory approach. The
author supports the contractual approach. He gives three features of
the contractual approach: (1) contractual modifications, i.e. the
inclusion of new clauses when new contracts are concluded or old
contracts are renewed; (2) a dispute resolution forum, which is also
common among other proposals; and (3) clarified official assistance.
The latter is to make sure that chances for moral hazard among
debtors and creditors in the form of an anticipated bailout are
limited.
For the document click here.
Alternative proposals
Which Sovereign Debt
Work-out Arrangements? Proposing a Model for Meaningful Debt Relief,
Raffer, K., 2002, paper presented during Alternatives to
Neo-liberalism-Conference of the coalition New Rules for Global
Finance, 23-24 May 2002, Washington D.C.; also presented during
EU-LDC Network conference 2002
In this paper the author
criticises the IMF proposal for its institutional self-interest.
This self-interest refers to the fact that the IMF will partly be
judging over its own claims. As an alternative, the author proposes
a debt work-out restructuring mechanism based on a different chapter
of the US Bankruptcy law, namely Chapter 9. Unlike Chapter 11 which
is for cases of corporate insolvency, Chapter 9 originally addresses
insolvency of municipalities. One of the main features of Chapter 9
is a clause for citizens in insolvent countries to address their
concerns. Furthermore, it advocates objective arbitration through ad
hoc panels which are independent from the IMF.
For the document click here.
Sovereign Debt Crisis
Resolution – The Benefits of the ‘Uncertainty Principle’,
Granville, B., in: The Business Economist, Vol. 33, No.1, 2002
The author of this
article doubts the role which the IMF can perform in international
financial markets on the whole as well as in debt restructuring
schemes. The author claims that the IMF and other Bretton Woods
institutions were suitable for the after war period, but they are
outdated for the current world. This stems from the fact that
interventionist approaches imply an ideal of world governance. The
IMF cannot be the co-ordinator in solving sovereign debt issues
since such a role for the IMF will lead to tensions between
governments and private actors. A debt restructuring mechanism in
itself is also undesirable because it stimulates moral hazard.
Rather, the factor of uncertainty will provide sufficient discipline
for debtors and creditors to avoid debt crises.
For the document click here.
Links
IMF’s
Factsheet on the Sovereign Debt Restructuring Mechanism (SDRM)
This site gives the
background of the discussion on SDRM from an IMF perspective. It
also contains links to articles and speeches from IMF officials
including the First Deputy Managing Director Ann Krueger.
Emerging
Markets Trade Association’s (EMTA) section on new financial
architecture
This site contains papers, articles and speeches on sovereign
debt restructuring written by representatives from EMTA, the
Institute of International Finance (IIF), the IMF and private
financial institutions.
Homepage of Dr. Kunibert
Raffer
This
site provides several articles on debt work-out mechanisms written
by Dr. Raffer.
Eurodad
section on debt arbitration
This site includes a section with
reports on debt arbitration and a section with news updates on the
issue. Eurodad, an NGO based in Brussels, opposes the IMF proposals.
It is more supportive towards the establishment of a Fair
Transparent Arbitration Process (FTAP) as is also suggested by
Raffer. Eurodad also rejects the contractual approach. The site
contains some commentaries on proposals of debt restructuring.
Erlassjahr.de
Erlassjahr.de
is a German member of the Jubilee Movement International. The
site provides English translations of documents originally written
in German. They mainly deal with alternative proposals for the IMF
scheme for restructuring sovereign insolvency.
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