EMTA SPECIAL SEMINAR: SOVEREIGN DEBT RESTRUCTURING: A BETTER WAY FORWARD?
Thursday, January 16, 2014
555 Twelfth Street, NW
11:45 a.m. – Registration
12:00 noon – 2:00 p.m. Panel Discussion
Whitney Debevoise (Arnold & Porter) – Moderator
Arturo Porzecanski (American University)
Lawrence Goodman (Center for Financial Stability)
Mikis Hadjimichael (Institute of International Finance)
Elena Duggar (Moody's Investors Service)
Douglas Rediker (Peterson Institute for International Economics)
Lunch will be provided
After the IMF’s proposal a decade ago for a Sovereign Debt Restructuring Mechanism (SDRM), and the adoption of the IIF's Principles for Stable Capital Flows and Fair Debt Restructuring and inclusion of collective action clauses (CACs) in EM bond issues, there have been various official sector and academic concerns about the existing mechanisms for restructuring sovereign bonds, particularly in response to developments in the European sovereign debt markets and pending litigation against Argentina.
EMTA hosted three panel discussions in New York and one in London. On October 16, EMTA presented a panel of sovereign debt experts, who described a variety of current proposals, including those being discussed within the IMF, to reform aspects of the international architecture for restructuring sovereign bonds. On November 5, another panel, composed of leading private sector representatives, gave their views on these proposals. On December 18 and January 13, other panels, composed of leading academics and law firm and private sector representatives (with a European emphasis for the latter panel), summarized these proposals and the private sector's reactions to them, and then articulated a sensible path forward.
Today's panel, with a more political emphasis, will also endeavor to summarize these proposals and the private sector's reactions to them, and then articulate a sensible path forward.
This Special Seminar is the fifth in a five-part series of EMTA panels on sovereign debt, the international architecture to restructure it and proposed reforms.
Attendance is complimentary.
EMTA Hosts Special Seminars on Sovereign Debt
Restructuring in NYC, London and Washington, DC: Argentina Situation Identified as an “Outlier”
Michael Chamberlin, EMTA’s Executive Director, welcomed the audience to the third in a series of five panels for a Special Seminar that EMTA held at its offices in New York on December 18, 2013: “Sovereign Debt Restructuring: A Better Way Forward?” This series of panels discussed sovereign debt, the international architecture to restructure it and proposed reforms, particularly in response to developments in the European sovereign debt markets and pending litigation against Argentina.
Chamberlin summarized the first panel, “The Road Ahead” on October 16 (which included representatives from the IMF, the UN and the International Capital Market Association (ICMA)), as providing a number of ideas to “improve” the architecture for restructuring sovereign debt (notably, proposals regarding the pari passu clause, so-called aggregation collective action clauses (CACs) in non-euro area sovereign bond issues and bailing in private sector bondholders as a condition of IMF support). In general, these proposals are designed to address serious concerns that many in the official sector, and in academia, have about the effect, or potential effect, that holdout creditors may have on future restructurings, especially in Europe. In essence, there is a prevailing official sector view that sovereign debt is still too difficult to restructure because of the inability to bind all creditors, despite the introduction of CACs over the course of the past decade.
He summarized the second panel market reaction discussion on November 5, “Private Sector Reaction to Current Proposals” (this time composed of private sector market participants), by noting that the private sector generally agreed that market-based restructurings usually worked well enough and that implementing the official sector’s proposals would tend to weaken creditor rights and were unnecessary. In particular, the second panel expressed the view that the Argentina holdout situation was an outlier, in large part because Argentina’s actions toward its creditors had been extreme. Also, the second panel was generally critical of the proposed Sovereign Debt Forum and expressed concerns about proposals for mechanisms that might “chase investors away”. He concluded by noting that one sentiment that tends to summarize the views of the second panel was that “sovereign debt restructurings are not supposed to be easy”.
For more information on the first two panels, Click Here.
Chamberlin remarked that much of the development of these types of policies occurs behind closed doors, in rooms which tend to be well-insulated from private sector involvement. EMTA’s goal is to provide a forum for the discussion of these important issues by market participants, with a view to ascertaining market sentiment and possibly strengthening private sector input into the policymaking process.
The third panel summarized the above proposals and the private sector’s reactions to them, and then articulated a sensible path forward. The panel was moderated by Arturo Porzecanski (American University), and included the following panelists: Bruce Wolfson (Bingham McCutchen), Claire Husson-Citanna (Franklin Templeton Fixed Income Group), Hans Humes (Greylock Capital Management) and Ben Heller (Hutchin Hill Capital). Relevant documents made available to the audience can be located at: http://www.emta.org/template.aspx?id=8413.
The third panel, with a view to strengthening private sector input into the public sector process, discussed both the underlying assumptions of the official sector’s proposals (e.g., the present system is badly functioning, holdouts and litigation are serious threats), as well as the reasonableness and workability of the main recommendations.
Arturo Porzecanski summarized the proposals, which he believed were primarily in response to the Greek and Argentine experiences, as follows:
1) Establish a presumption that some form of a creditor bail-in measure would be implemented as a condition for IMF lending in cases where, although no clear-cut determination has been made that the debt is unsustainable, a government has lost market access and prospects for regaining market access are uncertain. In such cases, the primary objective of creditor bail-in would be designed to ensure that creditors would not exit during the period while the IMF is providing financial assistance, giving more time for the Fund to determine whether the problem is one of liquidity or solvency.
2) Prevent holdout problems by adopting stronger CACs that operate across all new debt contracts, giving a supermajority among all bondholders the right to restructure against the will of a minority (in the aggregate, and regardless of the votes of individual bond series), as long as the restructuring leads to identical payment terms for all bondholders.
3) Create a European Sovereign Debt Restructuring Regime through an amendment of the European Stability Mechanism (ESM) treaty that defines conditions under which the ESM is allowed to lend, which would be implemented only if the member country also restructures its debt, and that gives guidelines as to the minimal amount of restructuring. The treaty change would also make the assets and payments of a euro area member that has undertaken an ESM-sanctioned restructuring immune from attachment by holdouts.
4) Set up a version of the dispute-settlement mechanism of the WTO, a system in which there are panels of experts who would host negotiations, subject to a deadline; if no agreement is reached, the second stage would involve the panel serving as an arbiter; and if agreement is still lacking, the panel would settle the dispute with a decision which would be binding on all.
The following were some of the questions Porzecanski posed to the panelists:
There followed a wide-ranging discussion of these questions.
With respect to the IMF proposal, Porzecanski described it as akin to the Fund demanding that countries in trouble which come to its Emergency Room agree to sign an “organ donor card” before getting any help, because the Fund wants the right to harvest an organ (namely, to force sovereigns to default and restructure their debts even if there is the slightest doubt of about their solvency) prior to providing the assistance to which its members are entitled.
Ben Heller noted that the IMF proposal would make the situation more unstable and uncertain, provoking unnecessary defaults and restructurings and giving more power to the IMF. Instead of carrying out a proper, ex-ante credit analysis of a sovereign’s fundamentals and debt sustainability, research analysts in investment firms will instead spend their time trying to guess what the IMF may be thinking vis-à-vis such a sovereign. He also questioned why the proposal required an unseemly emphasis on hasty, preemptive restructurings, when there is no failure to pay and other conditions warranting a default are not being triggered. This demonstrates a bias because the IMF is lending in the interim and it is in its interest not to prolong the process, while creditors are not as concerned about the timing as they are about the need for good-faith negotiations to get underway. This element of the IMF’s proposal is problematic, “like theology without hell”. It’s a “Rube Goldberg contraption to recalibrate the eco-system of the restructuring process”. He concluded by positing that the whole IMF proposal was “pre-textual”, meant to “defang creditors” and change the whole system of debt restructurings.
Hans Humes decried the lack of actual hands-on restructuring experience by IMF officials who, while truly believing there were problems that needed fixing, were prescribing solutions to a non-existent problem. He noted the irony of the IMF’s precipitating the very financial crises that it was seeking to avoid by its proposal, showing a complete lack of understanding as to the proposal’s ramifications for the financial markets. Market participants who see that the IMF is involved in a particular sovereign’s affairs will likely exit their debt holdings in such a sovereign in order to avoid being subjected to an inevitable haircut or even a standstill. This will increase volatility in the market without really addressing the underlying problem. It was all a “distraction”. He concluded that the IMF should spend time maintaining its senior-creditor status instead of worrying about the holdout “problem”.
While the IMF proposal has the merit of bringing all the parties to the table, Claire Husson-Citanna considered it a non-starter and was more concerned with its negative consequences, such as the writing of a “blank check” to the IMF if investors are going to be subject to the proposal, since the terms and conditions of the new restructured bonds will not be conclusively determined until much later in the process. She posited that any sovereign with liquidity problems would not be issuing Eurobonds that may fall within the purview of the IMF. She also noted that, if the IMF wants a super-holdout status, its proposal lacks any mechanical specifications to that end, and that holdouts seemed to be the privilege of the official sector and other supranational bodies. Also, the IMF seemed to be using creditors to send a message to the sovereigns: “when there’s a last supper and nothing to eat, everyone needs to be at the table and not in the corridors”.
Bruce Wolfson viewed the IMF proposal as a “full employment act” for lawyers and others and as an ill-conceived attempt to solve a problem that doesn’t seem to exist. What is the central issue and challenge should not be a focus on holdout debtors, but rather on holdouts like the IMF and Paris Club and holdout borrowers. Attempting to coerce every last creditor is a misguided endeavor. Energy should be placed in creative solutions and determining a sustainable level of debt when a sovereign can’t pay, so creditors can collect on their debt. The proposal’s message is that sovereigns are not the villains, but rather the creditors, who try to enforce what courts have already granted to them, are the problem. He agreed with Husson-Citanna that having all affected parties discuss the issues together was crucial, but noted that creditor committees can more easily and less intrusively serve that function.
Heller agreed that some would dispute there is a real holdout creditor problem. Given the low Argentina restructuring participation rate of 76% (which would not be deemed a successful restructuring), he suggested that 90-95% participation should be a condition for closing every restructuring deal. Humes agreed as well, noting that the 3% of creditors in the Greek restructuring that did not participate was not a problem for the other creditors or for the sovereign, so why did the IMF deem it a systemic problem - especially when other bodies were holding out on a 30% share of the debt? He also referenced the Moodys’ analysis and wondered why the IMF willfully ignored the study, which to him “telegraphed another agenda, with the private sector as the IMF’s soft problem”.
In response to the pros and cons of aggregation clauses, Wolfson noted that, in order to get a 90% acceptance rate, sovereigns sometimes need to agree to programs that are not very sustainable. While noting that a framework like bankruptcy is necessary to bring creditors into the fold (which works relatively well in the domestic context), an effort to cram-down creditors without enforcement on sovereign debtors is not effective, especially when there’s no impartial tribunal to determine what is a realistic plan of restructuring.
Husson-Citanna stated that some holdouts are not a problem (although the biggest issue is with European banks and NGOs), and that while CACs may solve some issues, the legal solution of aggregation clauses will not provide the right incentives for debtors and bondholders to move forward in the proper direction. Instead of discussing aggregation of CACs or worrying about changing existing documents, market participants should decide which sovereign bonds to purchase through an auction mechanism that matches buyers’ and sellers’ preferences. She also parenthetically noted that it was relatively easy to purchase a blocking position in a bond issue on its issue date to avoid a future cram-down of aggregation clauses, and that any aggregation clause design would ex-ante be insufficient to solve the majority of potential ex-post dissidence cases. Thus, ad-hoc financial incentivization is more efficient than ex-ante legal coercion.
Humes stated that there were too many layers in aggregation and that the system can be “gamed”. He also didn’t think the issue is all that relevant, given the possibility of creditor committees that can act in good faith in conjunction with borrowers. A debt restructuring that has a 95% acceptance rate is successful in that the 5% excess payment to holdouts can easily be absorbed. Further, he noted that the authors of these clauses have a conflict of interest, given the retroactive application of CACs to Greek law governed bonds designed by sovereign counsel who was also trying to design the new restructuring process. While seeming balanced, sovereign counsel is still representing borrowers’ interests, while severely impacting creditors’ rights.
Heller was more positive on aggregation clauses, which he thought can be useful. The private sector should be more involved in the design of contract provisions, rather than leaving it up to academics and lawyers who don’t have “skin in the game”. It may also be useful to use a section of the bankruptcy regime, while not the full-blown cram-down by a judge. The Sovereign Debt Restructuring Mechanism (SDRM) was problematic not because the market objected to rules or the notion that the majority can override the minority, but rather because there was no forum that creditors could rely on for enforcement. The IMF being “hostile to the private sector” was not a trustworthy option. This is a good opportunity to put the larger issue of attention to contract language in context, as well as to shore up inter-creditor issues, engagement clauses and information sharing.
Wolfson noted that the problem was not with cram-downs per se or with alternative dispute resolution mechanisms, which have been used across many areas. Aggregation clauses have not gained much traction because creditors have no real indicia of a good process. It is a creative proposal that represents borrowers and should be considered in that light; it should not be embraced as an objective solution to the problem. Instead, having representatives from both sides discussing options has statistically worked best for prior restructurings.
In response to the WTO-like arbitration panel, Heller said that he wouldn’t rely on the IMF or the UN to head it up, and what’s needed is a commensurate enforcement mechanism on sovereigns. “A panel that can with a stroke of a pen extinguish my debt versus having no enforcement power on borrowers [is not worthy of consideration]; let them come back to me when they have an army [to compel sovereigns]”. A forum can’t be convened if the end game doesn’t require enforcement on both parties; that power imbalance compromises the whole process.
Humes stated that, given the range of options, the IMF may not be the worst choice, but structurally it’s not the right body since its membership is comprised of representatives from only one side of the table – namely, sovereigns -- and it’s too political a group. Also, if the tribunal can’t bind both parties, there’s no point in continuing the discussion. Possibly borrowers could post bond as an ameliorating condition. He concluded that it’s good for the process to expose both views through creditor committees and otherwise. ABC, the creditor committee for the Argentine restructuring, would have been more successful in rounding up support for a reasonable proposal had the sovereign engaged with it, but the IMF should not use the bad example of Argentina as a reason not to promote such creditor committees as part of its proposal.
Wolfson was more positive on the objective panel, with an arbiter role to adjudicate what was a reasonably sustainable level of debt, together with an ability to provide adequate and transparent information, but he agreed that binding both sides was necessary -- although he did later on suggest that, even if there was an enforcement mechanism at the end of the process, it may still be worth considering this proposal more carefully. He also proclaimed that it seemed to be “a big solution to a small problem, and too much psychic energy and bandwidth” had been spent thus far in discussing it.
Husson-Citanna cited it as an innovative proposal, but suggested that an expert panel should be convened with representatives from the IIF and sovereign wealth funds who are also creditors. While the proposal has the advantage of providing a forum, it should not be left in the hands of debtors to run through their financial advisors; rather, the forum can “run the books” through auctions.
Remarks from the audience included the following:
Benu Schneider, moderator of the first panel discussion on sovereign debt restructuring, clarified that the tribunal was never proposed to reside at the UN. She echoed Porzecanski’s three proposed stages of this “shadow courthouse” and stated that the hope was not to reach the last stage, but rather have the restructuring negotiated within the first two stages.
Mikis Hadjimichael, a panelist on the upcoming DC panel from the IIF, informed the audience that the IIF will be publishing a paper on sovereign debt restructuring in mid-January, and that negotiations in good faith pre-default for any pre-reprofiling are an absolute necessity.
Tim DeSieno, a panelist on the second panel from Bingham McCutchen, questioned why the IMF was so fixated on holdouts, given investors’ lack of appetite for spending lots of money and time litigating to enforce their rights.
Porzecanski concluded the panel discussion by suggesting that it may be difficult to switch to an arbitration procedure when the market is used to NY, UK or local law, and there was nothing to stop a creditors’ committee from asking an objective third-party source about its views on debt sustainability issues. He viewed the real fight to be among the proliferation of official sector creditors vying for preferential treatment so they won’t be dragged into another European restructuring problem, like Greece.
The fourth in the series of five panels was held at Allen & Overy’s offices in London on January 13, 2014, with a European emphasis. The panel was sponsored and moderated by Yannis Manuelides (Allen & Overy), and included the following panelists: Charles Blitzer (Blitzer Consulting), Marc Balston (Deutsche Bank), Robert Gray (HSBC Holdings plc), Leland Goss (International Capital Market Association) and Dean Menegas (Spinnaker Capital Limited).* Relevant documents, which includes the ICMA Sovereign Bond Consultation Paper on Aggregated CACs, Pari Passu and Noteholders’ Committees, made available to the audience can be located at: http://www.emta.org/template.aspx?id=8461.
Background information was provided on why the Seminar was particularly relevant. Although the market seems to be welcoming jumbo issues by sovereigns of all sorts, not least from the Eurozone periphery, in the sovereign debt world we still very much live under the spectre of the GRs: Greece and Griesa. Or, at least this is what the IMF and others think. In April 2013 the IMF published its Sovereign Debt Restructuring: Recent Developments and Implications for the Fund’s Legal and Policy Framework, and launched a consultation process. This was followed by a number of other notable initiatives, such as the report, Revisiting Sovereign Bankruptcy by the Committee on International Economic Policy and Reform, sponsored by Brookings Institution. The think tank Bruegel had preceded the IMF proposal with a January 2013 proposal for a European mechanism for sovereign debt crisis resolution. The Bank of England published in November 2013 a paper entitled Sovereign default and state-contingent debt. In addition, there have been a number of other initiatives by other bodies, such as the United Nations Development Office, proposing a dispute resolution mechanism overseeing sovereign debt restructuring negotiations. Industry bodies, such as the international Institute of Finance (IIF) and ICMA have also provided their own comments and suggestions.
The IMF’s concerns are the following:
(a) “Debt restructurings have often been too little and too late (emphasis added), thus failing to re-establish debt sustainability and market access in a durable way”. IMF resources should not be available simply to bail out private creditors.
(i) The main issue here for the IMF is the “grey
zone” where there is still uncertainty on whether the sovereign is just
illiquid or also insolvent, and the sovereign has lost market access and the
prospects for regaining market access are uncertain.
(ii) For sovereigns in this “grey zone”, the IMF proposes “a presumption”, requiring that some form of creditor involvement would be implemented as a precondition for an IMF lending program. This involvement could take the form of a standstill, rollover or extension of maturities (re-profiling) as distinct from upfront nominal haircuts and debt restructuring that may be necessary in cases of insolvency. The involvement would be“voluntary”, but on the clear understanding that no IMF resources would be otherwise available to the sovereign.
(b) “The current contractual, market-based approach to debt restructuring is becoming less potent in overcoming collective action problems (emphasis added), especially in pre-default cases”.
(i) Because of the success of the Argentina holdout litigation and the relative success of holdouts of certain series of English law governed bonds in the Greek restructuring (19 out of 34, but at 6.5 million only 30% by value of foreign law bonds), the IMF proposes that:
(A) Aggregating CACs should become standard practice;
(B) The two-tier voting threshold should be replaced with a one-tier voting threshold (with the IMF acknowledging that this could “give rise to intercreditor equity concerns” especially in pre-default cases); and
(C) Its own financing would be contingent on appropriate aggregating CACs having been adopted by IMF members.
(ii) The IMF also notes that, notwithstanding the smooth manner in which credit default swaps (CDSs) were triggered and settled in Greece, important issues remain to ensure that the pricing matches the losses suffered by the protection buyers, and that the “restructuring credit event” is appropriate to the restructuring so that it is triggered.
(c) “The growing role and changing composition of official lending call for a clearer framework for official sector involvement (emphasis added), especially with regard to non-Paris Club creditors”. The IMF wants to ensure that:
(i) Heavy reliance on official lending may be perceived to subordinate private lending, hence preventing appropriate market access (probably too Greece-specific a problem); and
(ii) Fund policies on arrears to official creditors apply to non-Paris Club members as well as to Paris Club members.
(d) Although the collaborative, good-faith approach to resolving external private arrears embedded in the lending into arrears (LIA) policy remains the most promising way to regain market access post-default, a “review of the effectiveness of the LIA policy is in order in light of recent experience and the increased complexity of the creditor base”(emphasis added). In essence, the IMF proposes that:
(i) In pre-default restructurings, non-negotiated, unilateral offers by the debtor--following informal disussions with creditors--rather than negotiated deals, should be the norm (section 45); and
(ii) In post-default cases, the requirement for good-faith negotiations with representative private creditor committees should be revisited under the IMF’s LIA policy on the basis that it is too difficult for such committees to be deemed representative, given the wide diversity of interests of creditors.
After a comprehensive review of the issues, the authors of the Brookings paper proposed the following changes to the status quo:
(a) To deal with holdouts:
(i) Introducing aggregated one-step CACs, but allowing for a separate “per series” vote “if the terms of the proposed restructuring are not uniformly applicable across all the series of bonds”. Efforts should be made to accelerate the introduction of these aggregated CACs, including in debt exchanges.
(ii) Enacting legislation in countries of major financial centers that immunizes central counterparties, payments and clearing systems.
(b) To deal with the issues of “too late too little” (the authors speak of over-borrowing and procrastination), the following would apply:
(i) A new Sovereign Debt Adjustment Facility (SDAF) by the IMF, which will be available only to those countries who undertake restructurings;
(ii) New eligibility criteria for the SDAF would be introduced in advance by the IMF (as the IMF did for the Heavily Indebted Poor Countries). The SDAF could sit alongside the existing adjustment programme and facilities by the IMF, but, once the predefined criteria suggest that the debt is not sustainable, the IMF would only be able to continue assistance through the SDAF and require debt restructuring as a precondition;
(iii) The IMF’s Debt Sustainability Analysis (DSA) would be made available to its citizens, creditors and interested parties, and comments would be invited. Sovereigns would discuss the DSA with each affected creditor class, the IMF would review the restructuring proposals and the restructuring would require 75% of all affected debt instruments; and
(iv) The assets of the debtor country would have immunity against holdouts.
(c) Introducing a similar regime for the Eurozone, with the ESM in the role of the IMF, and the criteria for lending with and without restructuring based on the core financial pact of the Eurozone and the immunity legislation in the ESM Treaty.
The Bank of England’s paper proposed the adoption of:
(a) Sovereign contingent bonds (sovereign co-cos), which would automatically extend in repayment maturity when a country receives official sector emergency liquidity assistance; and
(b) GDP-linked bonds, whose principal is linked to GDP fluctuations and whose fixed coupon is therefore also dependent on a fluctuating principal amounts.
The many questions that arise from these proposals fall broadly in two categories, strategic policy and process, and the moderator posed various questions to the panelists.
1. An underlying assumption of all of these analyses is that the system is broken and needs radical fixing. Is the system for debt restructuring crisis broken or not functioning well? Is it the case that sovereign debt restructurings in general have been a case of “too little and too late”?
(a) What exactly are problems?
(b) And, if that is the case, what, if anything, might be done to address this?
2. What are the key issues which could be addressed to improve the architecture of the sovereign debt market?
3. What are the pros and cons of the IMF proposal for a voluntary debt “reprofiling” as a condition for programs when debt sustainability is in doubt?
4. What are the key issues which could be addressed to improve prevention, management and restructuring of sovereign debt in crisis?
(a) In particular, is the two-step approach in the Brookings paper (adjustment facility + SDAF) a clearer way forward for the IMF to try to deal with the grey zone of loss of market access?
(b) Can the Bank of England’s proposed instruments assist either with a variant of the first stage of the IMF or Brookings proposals?
(c) Is prevention better served through improved standards and requirements for disclosure and regulatory treatment? Have we done all that we can?
1.How serious a threat to future restructurings is the Argentina pari passu case?
2. What are the most important changes that need to be made in bond documentation to improve the speed and efficiency of restructurings? (i.e., pari passu clauses, aggregation clauses, engagement clauses, automatic restructuring, such as sovereign cocos, other)?
3. How likely will a modified or eliminated pari passu clause result in sovereigns offering less favourable terms in a restructuring?
4. The IMF paper makes the case for single limb aggregated voting as one way to reduce the holdout risk: what are the pros and cons of single limb aggregated voting? Since the EU has adopted a double limb approach in its standardized CACs, is it really feasible for the market to sponsor a mechanism that is less creditor friendly? What are the pros and cons regarding 1-step vs. 2-step aggregation clauses? What should the thresholds be set at? Do quorum requirements serve any useful purpose today?
5. How easily would the aggregating CACs work for bonds denominated in different currencies, governed by different laws, subject to the jurisdiction of different courts and structured in different ways?
6. The IMF staff argue that contractual, market-based approaches have become “less potent” in overcoming collective action problems, particularly in pre-default cases, and, in particular, question the feasibility of representative creditor committees being formed on a timely basis. These arguments are used to support the case for non-negotiated offers by the debtor. Should these arguments and the conclusions that the IMF staff have drawn from them be accepted?
7. It is argued that the current Argentine litigation will embolden holdout creditors and increase the risk of creditors boycotting future sovereign debt restructurings. Are holdouts as big a problem as many in the official sector appear to think?
A discussion ensued among the panelists and audience on the various topics raised, focusing primarily on the IMF’s analysis and policy prescriptions.
Regarding the IMF’s conclusion that often debt restructurings were “too little, too late”, the panel’s view was that this conclusion was mostly an assertion with little empirical evidence or clear analytical framework to back it up. Panel members’ critiques emphasized that, over the past several decades, most large IMF programs were successful in restoring macroeconomic balances and restoring normal market access with resort to disruptive restructurings. Examples in this category, which were completely ignored in the IMF report, include Brazil, Turkey, Mexico, Korea, Ireland and Portugal. The IMF’s list included several small Caribbean countries which have had to restructure a second time recently due to the global financial crisis which no one had anticipated. Several panelists also pointed out that there is strong evidence that ex post the haircuts in a number of other sovereign bond restructurings look too high. Panelists were in agreement that the “too late” problem was delayed adjustment by borrowers, virtually always due to domestic political considerations, and not reluctance of creditors to engage or even restructure when required.
The recommendation in the IMF report that there be a “presumption” of some “modest” amount of debt restructuring whenever debt sustainability is not highly likely was criticized extensively both by the panel and general audience as a step in the wrong direction, with negative consequences for borrowers and creditors. The main points raised were:
The panelists agreed that the process for restructuring sovereign bonds, while not perfect, has worked quite well. Several panelists cited studies by Moody’s and the IMF itself which concluded that – with the notable exception of Argentina – bond restructurings have been completed more quickly than was the case for bank loans, participation has averaged more than 90%, and the debt relief provided has been consistent with financing needs identified by the IMF. While participation has always been less than 100%, the panel concluded that ex post holdout problems were most unlikely to pose a serious threat for future restructurings. There has been no post-restructuring litigation involving sovereign bonds except for Argentina, which has pursued a uniquely unilateral and creditor-unfriendly approach. The market has proved willing to allow a reasonable level of non-participation to be priced into exchange offers, such as in the case of Greece where the IMF/EU DSA was based on an exchange which would receive 92% support. The actual 96% level of participation resulted in a small windfall for the Greek government.
The panel discussed several improvements to the contractual approach which could result in bond restructurings being concluded more quickly and with higher participation. Panelist focused primarily on aggregation clauses, creditor engagement clauses and pari passu clauses, all of which have been put forward in detailed form in a discussion document prepared by ICMA.
The panel was broadly supportive of aggregation clauses, but had somewhat different views on the details. Most panelists supported a 2-step approach, which requires reaching minimum thresholds of support within each series, as well as an even higher threshold aggregating across series. In their view a 1-step approach, requiring no minimum within a series – as proposed by the IMF and the Brookings report -- would be a serious erosion of creditor rights, would be ex ante resisted by investors and also would open the door to serious intra-creditor equity issues, which could undermine broad support for an exchange offer. In the view of these panelists, a 1-step approach is unlikely to affect pricing, avoids collusion so that the majority doesn’t impose its will on a minority series of bonds, and has the advantage of incorporating the views of a particular series of bonds. One panelist supported 1-step aggregation clauses, pointing out that they may also be more reflective of the credit risk decisions made by all creditors who invest in a particular sovereign, and, thus, all such creditors should be in the same position to vote on a restructuring, without having inter-creditor calculus be part of the decision-making process. Other panelists argued that any acceptable 1-step clause would require some safeguards against unfair treatment of a particular series. Several panelists suggested that the specific thresholds in the draft ICMA clauses were too low in relation to the 75% super- majority, which is the convention in Emerging Markets sovereign bonds and should be reconsidered.
The panel concluded that, because early engagement with creditors, especially with broad-based creditor committees, has proved useful in achieving speedy and equitable restructurings, strong engagement clauses should be part of standard bond documentation. The panel expressed favorable views on the draft clause prepared by ICMA and the similar clause which Belize introduced into its new bonds following its 2013 restructuring. The key feature of an engagement clause should be that, if a committee is organized with the support of a majority, the debtor government should recognize the committee, negotiate with it and pay reasonable costs incurred by such committee.
The panel put forward a number of recommendations for the IMF regarding its policies in connection with debt restructurings.
In assessing the IMF’s proposals (and other recent papers such as the Brookings report), the panel noted that currently there is no sanctity of contract or its enforcement, no equality of bargaining power, with sovereigns being above the law and with assets that cannot be effectively attached. The IMF proposals are viewed as giving sovereigns even further power by imposing restructurings on the private sector (instead of carefully analyzing the amount of cash flow relief that’s really required), with no good-faith negotiations required and no engagement clauses to ensure the integrity of the process. The system does not need radical change, and as one panelist opined, they represent “solutions in search of a problem”.
* Please note that, since the panelists’ remarks
were off the record and not for attribution (generally in accordance with the
Chatham House Rule), this summary will only contain references to the
discussion points and not the identity of the panelists who made those remarks.
The fifth in the series of five panels was held at Arnold & Porter’s offices in Washington, DC on January 16, 2014, with a more political emphasis. The panel was moderated by Whitney Debevoise (Arnold & Porter) and included the following panelists: Arturo Porzecanski (American University), Lawrence Goodman (Center for Financial Stability), Mikis Hadjimichael (Institute of International Finance), Elena Duggar (Moody’s Investors Service) and Douglas Rediker (Peterson Institute for International Economics). Relevant documents, which includes Moody’s slide presentation, made available to the audience can be located at: /new-developments/passworded-archives/older-pw-live-content/0600-ecag-etc/special-events-unpassworded/sovereign-debt-restructuring-a-better-way-forward-jan-16-2014/.
Whitney Debevoise asked the panel for its reactions to the various proposals and ways forward to improve the debt restructuring process and outcomes, including creditor committees and better creditor engagement procedures and debt sustainability. He questioned whether the IMF proposal was a reiteration of a rules (harkening back to the SDRM days) vs. case-by-case approach to restructuring and whether restructurings were indeed derailed by holdouts. Douglas Rediker provided background information on why the IMF published its April paper, stating that it was not intended as a formal proposal (although it was carefully crafted with an agenda). He viewed it as a series of “non-proposals”, addressing issues that haven’t been addressed for a decade (since the SDRM debate), so the time seemed to be ripe in the IMF’s mind to review them anew. When the April 2013 paper was published, there was relative silence in response, but as we’ve seen from the mounds of analysis on those proposals, reaction to the proposals has become a cottage industry, with much-needed dialogue among potentially affected parties (as well as within the IMF where there is still no consensus on the proposals).
Catalysts for the proposals, Argentina (because it is a uniquely recalcitrant debtor and an exceptional case that is unlikely to be repeated) and Greece (because everyone knew they were using creative accounting to become part of the Euro monetary system), were insufficient to support the IMF’s rationale that it should attempt to propose changes to the global sovereign debt restructuring system. With restructurings seeking IMF support deemed “too little, too late”, the proposals sought to force debtors to ask for relief early in the process so that the IMF wouldn’t have to over-pay to bail-out debtors, as well as to bail-out investors. The basic thesis was to make adherence to the proposal’s requirements so rigid as to remove the political influences on the IMF, as well as take any judgment or discretion out of its decision-making process. The IMF’s suggestion of a pre-emptive presumption in favor of bail-ins would be rules-based - not country-specific. However, in reality there is no “one size fits all” approach to debt sustainability. While attempting to bring transparency into the process, the IMF proposals would make it all the more opaque, leaving “sustainability” to the discretion of the IMF staff.
The presumption of a bail-in (restructuring) with its attendant standstill requirements (an event of default under ISDA documentation, thus leading to CDS triggers) makes it more likely than not that a sovereign will wait longer to come to the IMF and will increase risks to investors which, in turn, makes it more likely that the price of funding will be higher for such sovereign. Now the hard-coding of such imposed ex-ante pre-condition will make the restructuring process even more difficult to predict and possibly much less successful. Rules may be useful, but the world is a messy place and when IMF programs are being crafted, judgment and discretion are far more important. The question should not be framed as whether the system is broken, but rather whether it can be improved, and the current environment is nowhere near the catalyst to justify these “non-proposals”.
Arturo Porzecanski summarized the two other types of proposals, the first being contractual changes that make restructurings easier through aggregation clauses (not bond-by-bond voting), engagement clauses to encourage dialogue, and amendments to pari passu clauses to clarify to what extent all creditors are identical and should be paid as such. However, he questioned the value of changing provisions when enforcement of the overall contract against a sovereign debtor is so difficult, and hoped that ongoing litigation will help elucidate the meaning of such provisions and their enforceability.
The second type of proposal related to reforming the way the IMF and ESM operate. The Brookings Institution proposal is a derivative of the IMF proposal, by suggesting that the ESM Treaty should be amended to include IMF-type of pre-conditions, thus forcing a restructuring early in the process. However, this approach is self-defeating and will aggravate existing problems. Investors and analysts will rightly have to push the alarm button if an ailing sovereign approaches the IMF or the ESM for help. The proposals are perceived by the market as part of the problem, not the solution, providing a bad signal and potentially destroying any remaining demand for sovereign bonds in cases of uncertainty. Research has shown that the private sector is not coming too late into the restructuring process, and when “there’s a will, there’s a way”. Instead, the debtors may now delay coming to the table, fearing IMF involvement will scare investors away. Moreover, the proposals are likely to aggravate whatever holdout problems currently exist, as more investors will hold out at the outset, instead of choosing to be subjected to an official sector cram-down. In fact, the threat of holdouts serves the useful purpose of keeping the sovereigns, who usually want to regain market access, honest and more likely to bring better deals for creditors’ consideration.
The proposals seem to be based on self-interest: to buttress a restructuring industry that stands to gain from more restructurings, and to decrease the resources that the IMF has to disburse. In addition, the “troika approach” to debt problems in Europe has run into practical difficulties, so these proposals are the IMF’s way to set itself ahead and apart from others in the official sector that, in the case of Greece, have managed to claim the kind of seniority that the IMF has long enjoyed. Thus, it may be the case that the European governance vacuum is feeding this defensive response from the IMF. The holdout problem resides in the official sector, wherein too many European institutions desire preferred creditor status and exempt themselves from sovereign debt restructurings.
Elena Duggar provided the rating agency perspective on the proposals, which was that the IMF proposals are credit negative for investors in distressed-country bonds. She remarked on how the default rate for sovereigns with IMF programs was two times as high (16%) as the default rate for sovereigns without IMF aid, and that, since 1997, those sovereigns that imposed large haircuts on investors as part of their debt restructuring experienced a long period of market exclusion. Most sovereign restructurings were resolved relatively quickly (four months) with good coordination between debtors and creditors and with no litigation or significant amount of holdouts (Argentina being the obvious exception). Typically, the pari passu clauses in sovereign bond contracts are not uniform and the vast majority of them are not susceptible to Argentina-style litigation. Further, most sovereign bond contracts already contain CACs, and exit consents may be another useful existing strategy in sovereign debt restructurings.
Mikis Hadjimichael informed the audience that a new IMF draft of the proposals was expected in June. He stated that it was surprising that the unilateral Argentine offer only resulted in a 7% holdout litigation problem and that not all holdouts enter into litigation; thus Argentina is not a good example of what needs to be fixed in the restructuring process. Any contractual approach must not be forced or interfere with the contractual relationship between debtors and creditors. To do otherwise would create bad will and contribute to a negative market reaction.
The way forward is by having more transparency since information-sharing and good-faith negotiations are fundamental to promoting goodwill and fair burden-sharing and averting or pre-empting a crisis. Two-tiered CACs are preferable so that the majority doesn’t impose its will on the minority series of bonds. Creditor committees, deemed difficult to form due to differing and widely varied creditors with different concerns, are actually easy to form because of the creditors’ commonality of purpose to find a solution.
Lawrence Goodman complimented the IMF for taking on the issue of sovereign debt restructuring, as best practices are essential. He welcomed emphasis on the DSA and the move away from protracted and postponed discussions in favor of speedy resolutions. However, the IMF seemed to be missing a crucial element – the private sector. Paragraph 31 of the IMF proposal indicates that debt sustainability assessments will remain discretionary, leaving the IMF to determine when to declare a country’s debt unsustainable. This would be a mistake. Debtors and the private sector need to be involved and incentivized in the process as well, at the analytic and negotiating table. The “take it or leave it” deal is no longer viable, a thoughtful approach is necessary.
In 1944, Keynes, at the Bretton Woods founding of the IMF, declared that “the settlement of…debts must be…a matter between those directly concerned…The Fund was not intended to deal directly with…indebtedness”. However, the Fund can help demonstrate leadership today by 1) facilitating the sharing of information between debtors and creditors and 2) prioritizing direct communication between debtors and creditors or engagement. Namely, the formation of creditor committees is essential.