Sovereign Debt Restructuring: The Road Ahead - October 16, 2013 The Road Ahead - October 16, 2013
Special Seminar- Sovereign Debt Restructuring: The Road Ahead - October 16 and November 5, 2013

EMTA SPECIAL SEMINAR: SOVEREIGN DEBT RESTRUCTURING: THE ROAD AHEAD
in cooperation with Financing for Development Office, UNDESA
Wednesday, October 16, 2013  

EMTA
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York
 

10:15 a.m. – Registration  

10:30 a.m. – 1:30 p.m. Panel Discussion

Benu Schneider (United Nations) - Moderator
Lee Buchheit (Cleary Gottlieb Steen & Hamilton)
Deborah Zandstra (Clifford Chance)
Andrew Powell (Inter-American Development Bank)
Sergio Chodos (International Monetary Fund)
Sean Hagan (International Monetary Fund)
 

Lunch at 12:00 Noon  

Following the IMF’s proposal a decade ago for a “Sovereign Debt Restructuring Mechanism (SDRM)”, there have been various concerns about the need to improve the existing mechanisms for restructuring sovereign debt, including the Principles for Stable Capital Flows and Fair Debt Restructuring and the inclusion of collective action clauses (CACs) in bond issues.  

The IMF is taking a new look at sovereign debt restructuring and will be reviewing its policies in the near future. In the belief that the status quo in dealing with debt problems is costly for everyone, various expert groups have been set up in international institutions, policy think tanks and some governments to examine options for enhancing the international architecture for debt restructuring. This panel will share the current status of these ongoing discussions and will invite participation from the audience to share views on the best options for the road ahead. Key questions are: What steps can be taken to improve upon the prevailing ad hoc approach for restructuring sovereign debt? Are some elements of a more formal approach needed?  

This Special Seminar is part of a continuing series of panels on international financial architecture. Our next panel on November 5 will explore market reactions to the recent initiatives discussed at this Seminar, and our third panel will explore the pros and cons of the various proposals.  

Attendance is US$75 for EMTA Members / US$495 for non-members / This Seminar is closed to the press.  

 

EMTA SPECIAL SEMINAR: SOVEREIGN DEBT RESTRUCTURING: PRIVATE SECTOR
REACTION TO CURRENT PROPOSALS

Tuesday, November 5, 2013  

EMTA
360 Madison Avenue, 17th Floor
(on 45th St. between Madison and 5th Aves.)
New York
 

11:45 a.m. – Registration  

12:15 p.m. – 2:15 p.m. Panel Discussion

Charles Blitzer (Blitzer Consulting) - Moderator
Tim DeSieno (Bingham McCutchen)
Gerardo Rodriguez (BlackRock)
Jay Newman (Elliott Management Corporation)
Rashique Rahman (Morgan Stanley)  

Support for this event provided by Bingham McCutchen and Morgan Stanley.  

A Light Lunch will be provided  

After the IMF’s withdrawal of its 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.  

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.  

Today's panel of leading private sector practitioners will provide their own views on the current sovereign debt restructuring architecture and on the various proposals to reform it.  

This Special Seminar is the second in a three-part EMTA series of panels on sovereign debt, the international architecture to restructure it and proposed reforms. Our third panel on December 18 will endeavor to summarize the official sector and private sector positions and articulate a sensible path forward.  

Attendance is US$75 for EMTA Members / US$495 for non-members / This Seminar is closed to the press.  

   

EMTA Hosts Special Seminars on Sovereign Debt Restructuring 

Michael Chamberlin, EMTA’s Executive Director, welcomed the audience of 65 market participants for a Special Seminar that EMTA, in cooperation with Financing for Development Office, UNDESA, held at its offices in New York on October 16, 2013: “Sovereign Debt Restructuring: The Road Ahead”.  This was the first in a series of seminars on 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

The first panel was moderated by Benu Schneider (United Nations) and the other panelists included Lee Buchheit (Cleary Gottlieb Steen & Hamilton), Deborah Zandstra (Clifford Chance), Andrew Powell (Inter-American Development Bank (IDB)), Sergio Chodos (International Monetary Fund (IMF)) and Sean Hagan (IMF).  The panel discussed a variety of current proposals, including those from the IMF and the International Capital Market Association (ICMA) relating to the inclusion of aggregated collective action clauses (CAC’s) in non-euro area sovereign bond issues, to reform aspects of the international architecture for restructuring sovereign bonds.   

EMTA’s second panel on November 5, 2013, “Sovereign Debt Restructuring: Private Sector Reaction to Current Proposals” was moderated by Charles Blitzer (Blitzer Consulting), with other leading private sector representatives, including Tim DeSieno (Bingham McCutchen), Gerardo Rodriguez (BlackRock), Jay Newman (Elliott Associates) and Rashique Rahman (Morgan Stanley), who represented the market’s reactions to the official sector’s and other proposals.

The third panel, to be held on December 18, 2013, at EMTA’s NYC offices, “Sovereign Debt Restructuring: A Better Way Forward?”, will endeavor to summarize the above proposals and the private sector’s reactions to them, and then articulate a sensible path forward.  The panel will be moderated by Arturo Porzecanski (American University), and include the following panelists: Whitney Debevoise (Arnold & Porter), Bruce Wolfson (Bingham McCutchen), Robert Koenigsberger (Gramercy), Hans Humes (Greylock Capital Management) and Ben Heller (Hutchin Hill Capital).  EMTA will replicate this third panel in London on January 13, 2014 and in Washington, D.C. on January 16, 2014.

Relevant documents made available to the audience can be located at: http://www.emta.org/template.aspx?id=8330.

 

First Panel on October 16, 2013 

The sovereign debt restructuring reform topic was introduced with the moderator stating that the overall objective was how to return a country to a sustainable fiscal track and resuscitate growth and balance the risks which debt restructuring poses to the banking system.  Every decade or so, “intellectual energy” is generated by the private and public sectors who review this topic (in the 1980’s with the Latin America crisis, in the 1990’s with the Brady plan, in the 2000’s with the Sovereign Debt Restructuring Mechanism (SDRM) proposal and the adoption of CAC’s in international sovereign debt issues and the present day with the emphasis on further contractual enhancements, such as aggregated CAC’s) and propose solutions.  What is the catalyst for the ensuing discussion?*

Several contributing factors serve as the catalyst for reigniting the debate on sovereign debt restructuring — the ongoing debt problems of some members of the Eurozone; the limits of implementing adjustment programs through the compression of domestic “absorption”; the scale of resources required to bail out Greece, which portends difficulties for the official sector if more countries find themselves in a similar situation; the issue of hold-out creditors as a result of the ongoing Argentine litigation in U.S. courts, which may increase the leverage of hold-out creditors (which, for some panelists, gave the hold-out creditors rights to interfere with exchange bondholders’ debt, and which, by crystallizing a ratable payment legal interpretation of the particular pari passu  provision, may make future restructurings more difficult); the full payment to the hold-out creditors in the Greek restructuring; the multiplicity of creditors and the unprecedented size of Greece’s debt restructuring; and the real possibility that many countries may not be in a position to return to growth and stability without a debt restructuring, which has significant implications for the role of the IMF and its financing, and the timing and extent of debt restructuring.

In reviewing the characteristics of past restructurings, one panelist reviewed the past history of debt restructurings and found that most had low present value haircuts, most of those had no principal haircut, but some had large present value haircuts with principal haircuts, but with very few in between.  The probability of multiple restructurings for any given country within six years was rather common, especially when there were low present value haircuts.  Fear of hold-outs could be one of the reasons for low present value restructurings in order to get a buy-in from all creditors, thus making it more likely that a country may seek further restructurings subsequently.   

A longer delay between the date of default and the date of restructuring correlated to a larger haircut.  This can be explained because, inter alia, the deeper the sovereign problem, the greater the incentives may be to delay fixing such a problem.  Another explanation can be that the delay is part of the problem.  Any delay reduces the size of the pie and is detrimental to both the debtor country and its creditors, with the apt adage of “too much pain for too little gain”.  Since debt overhang is then often associated with large economic deadweight costs, it behooves sovereigns and creditors to look for improvements to the current mechanisms for restructurings, so that future restructurings can be conducted in an orderly, timely and economically efficient manner.  Settlement with hold-out creditors may jeopardize the intended purpose of a restructuring.

The following are some of the questions posed to the panelists by the moderator:

  • What implications does the present framework have for the IMF’s own role and how the evolution of international financial crises—from current account problems to capital account crises—has impinged on its ability to assist members to strike a judicious balance between financing and adjustment?  What are the implications for the Fund’s lending-into-arrears policy and its exit strategy from a country whose debt has become unsustainable?  How can the issue of “too little, too late” be resolved?  Should there be limits to over borrowing as a crisis prevention measure?  How can the threat of contagion be minimized?  How can the challenge of promoting a debt restructuring that is necessary to return the country to a sustainable fiscal track and resuscitate growth be balanced with the potential risks a restructuring poses to the banking system?  The IMF’s debt sustainability analyses play an important role in the process, but the role of the IMF has been hotly debated of late, in part because of its potential to subordinate private claims through its own lending.  How can issues of priority and inter-creditor equity be resolved?
  • A decade ago, efforts were made to replicate the key features of domestic bankruptcy regimes through the IMF’s SDRM proposal.  In the end, these efforts were shelved in favor of a “voluntary” contractual approach based on CAC’s and codes of conduct governing the restructuring process.  Where does this process stand?  And how would you evaluate their effectiveness?  What problems have CAC’s and code of conduct resolved and which issues still need to be addressed?  In the absence of a sound bankruptcy regime at the international level, what difficulties do you identify in the present process and what are the options on the table to replicate the functions of a bankruptcy regime?  What can be done?  Is there a scope for more complete standardized contracts, which for completeness could also have provisions for breathing space, a standardized pari passu clause, and a simplified aggregation clause?
  • In the event that there are more countries in debt distress (like Greece was), is there a risk that private bond markets would close to sovereign borrowers, as had been the case following the widespread defaults in the 1930’s?  To what extent to do you think this is likely, and how would it affect the debate between “voluntary” and “statutory” approaches?
  • The ongoing Argentine litigation in U.S. courts may increase the leverage of holdout creditors.  If the decision were upheld, would it affect the future of sovereign debt restructuring?  Would this give an impetus to the statutory approach to sovereign debt restructuring?  To what extent can the goals associated with timely, orderly restructurings be achieved with purely voluntary mechanisms and whether some form of quasi-statutory framework is necessary?  What are the options for the latter?

There followed a wide-ranging discussion of these questions.

While recognizing the limitations of the existing legal framework and seeking contractual improvements and reforms (which will be prospective), the IMF is not likely to resurrect the SDRM (which panelists agreed was not a particularly good analogy to U.S. Bankruptcy Chapter 11 anyway), or any other statutory framework, to address the issues surrounding sovereign debt restructuring.  The viability of any proposals implemented by the IMF will depend upon market acceptance (although the IMF does not generally intervene directly in inter-creditor issues or disputes).

The two contractual provisions that merit further review by market participants and trade associations (including ICMA) are (i) the pari passu clause in light of the Argentine litigation (with its implications for future sovereign debt restructurings, hold-out strategy and leverage over participating bondholders that may not get paid, as well as trustee and other third party intermediaries and infrastructure providers) and (ii) CAC’s, including aggregation clauses to neutralize the effectiveness of creditors taking a large position in individual series of bonds with a view to building a blocking position for voting purposes, thereby making restructurings potentially more difficult.

Expanding on the legal framework, there is currently no standard pari passu clause, with differing language even within the same sovereign’s bonds.  Capital markets would function better with more uniform and more easily understood provisions.  Presently, there are two formulations - one, that the clause requires equal ranking and two, that the clause requires equal payment (with sometimes varying interpretations).  While some counterparties may have contemplated ex-ante that the clause in their contracts be interpreted to require equal payment, most believe that the equal ranking formulation is preferable (and ICMA will endorse that view by drafting language that recommends that formulation).  Other market participants would wish the clause to be deleted from documentation in its entirely.

With respect to CAC’s and aggregation clauses, the Eurozone has, as of the beginning of 2013, adopted a new model aggregated CAC clause which employs a two-tiered voting structure, requiring a super-majority of 75% of the outstanding bonds represented at a duly called bondholders’ meeting to aggregate across series, and a single series approval requirement of 66-2/3% of the outstanding bonds represented at such meeting.  Future issuers could consider reducing the single series required voting threshold to the lower level of at least 50% to mitigate the risk of hold-out creditors.  In addition, CAC’s generally were not included in New York law governed bonds issued before 2003, and aggregated CAC’s were not included in euro area sovereign bonds before January 2013, thus optimistically one cannot rely on CAC’s to minimize the hold-out problem for at least a decade or more from their adoption (as those older dated bonds mature or are retired or exchanged).  While Greece retroactively applied a collective action mechanism to its domestic law governed bonds and Uruguay neutralized hold-outs with its unique exit consents, future sovereigns in trouble may not be able to use those tactics.  And, if there are perceived successful avenues for holding out, creditors may be less likely to agree to participate in a restructuring.

However, other than a handful of LatAm sovereigns and the euro area initiative on the adoption of aggregated CAC’s (which uniquely applies across both domestic law and foreign law government debt securities), CAC’s currently in use do not include an aggregation feature.  Such an element could further minimize the hold-out creditor problem, especially if the voting structure of an aggregated CAC was such that the approval process was centered on an overall aggregate voting mechanism (across all series of instruments to be restructured).  However, the requirement to include a series-by-series voting procedure (resulting in a two-stage voting structure, the aggregate one and the individual series one) provided an important legal safeguard in the area of enforceability of such provisions, and the proper use of majority powers.  One emerging concept was that, to the extent  that bondholders could be offered the same menu of new bonds across all series, no single series voting would be required.  But, this may be problematic from a market acceptability perspective, since different creditors of a sovereign may have differing interests and trading values may or may not converge.  Any move away to a single aggregate voting mechanism needed to be considered carefully from a legal and market perspective.  The legal issues would go to enforceability.  The market analysis would require thought to be given to any potential primary and secondary market pricing implications, as well as any ratings implications, especially at a time when a sovereign was facing decreasing creditworthiness.

In terms of additional measures which could be considered in the context of Europe, a recent proposal by a committee of experts and academics suggests that the ESM Treaty (establishing the euro area financial stability mechanism) could be amended so that the assets of a sovereign located within the Eurozone would be immunized from attachment by those creditors not participating in any such sovereign’s debt restructuring where that sovereign was benefitting from a financial assistance program from the ESM.  Previous precedents for this approach to implement a restructuring are when (i) the UN Security Council passed a worldwide resolution in which Iraqi assets were so immunized from attachment and (ii) Uruguay adopted “surgical” exit consents that made express waivers of sovereign immunity no longer applicable.  Had the 2005 Argentine deal included such exit consents, the course of history may have been changed (in light of the fact that the Foreign Sovereign Immunities Act may be the basis for U.S. Supreme Court review).  However, the kind of statutory solutions referred to above may not work in all contexts (for example, they may not work for Grenada).

The IMF has been accused of “too little, too late”, but if it implements some proposals it may be accused of “too soon, too much”.  The IMF Staff is reviewing its own lending-into-arrears policy and how to resolve the issue of “too little, too late” in sovereign debt restructuring.  It is looking into possible options to deal with the grey zone between loss of market access and debt “unsustainability” - the IMF Staff proposes to bring in reprofiling by the private sector at this stage.  The timing of a debt restructuring is critical, with the delay in initiating the restructuring being more important than its conclusion.  The IMF has a central role in the restructuring process since experience has shown that most sovereigns don’t initiative it on their own (and creditors are also not too keen on it, given the added costs).  Moral hazard and the stability of the international financial system were discussed, as were debt sustainability issues since the IMF’s lending framework requires that the debt be sustainable and the attendant liquidity and insolvency concerns in the sovereign context make the sustainability analysis more difficult.  Also, debt sustainability may be equated with market access or growth, making it more difficult to assess.  And, standstill arrangements may not be feasible with the number of creditors involved (in contrast to the banking loan era of the 1980’s where standstills were a viable tool).  Some work is ongoing to include breathing space in bond and loan contracts.

The IMF should have a strong lender of last resort role to counter problems of contagion and to guard against liquidity crises and to prevent them wherever possible becoming solvency problems.  The crisis in Brazil in 2002/3 is a good example of this role in practice.  It is important that any new changes in the IMF modus operandi would maintain this important role.

The IDB has somewhat similar procedures to the IMF’s in that budget support can only be approved if IDB Staff indicate that the macroeconomic situation is sustainable.  There is considerable dialogue between the two institutions in countries with difficult macroeconomic circumstances in the Latin America and the Caribbean region.

If debt restructuring has significant and unnecessary economic costs, it is also important to consider innovations in contracts that might make debt restructurings less frequent.  Introducing contingencies in debt contracts such as GDP indexation or indexation to a relevant commodity price are potential examples.  Ideas to reduce the economic costs of restructuring have also been suggested, such as contracts with clauses analogous to banks’ “contingent capital” instruments (or Coco’s).  Such clauses could trigger an automatic extension of maturities or immediate debt reduction, with or without GDP warrants attached.  A further more institutional idea that may be useful would be a dispute resolution mechanism with a panel of experts to guide the discussion among the debtor and all of its creditors that is voluntary, but time-bound with sanctions.  A number of mechanisms were presented from previous expert group meetings organized by FFDO-UNDESA and IDB.  These included increasing information on debt stocks and flows by establishing an international registry of debt; the implementation and specific rules on stand-stills and regulatory, tax and accounting treatments that may currently interact to make debt write-downs overly costly.

One approach which combined the voluntary with the statutory approach consisted of three stages similar to the WTO dispute resolution mechanism: (1) voluntary, but time-bound, negotiation between the parties, (2) a time-bound mediation following the WTO dispute resolution process, and (3) if no agreement is reached, a judicial ruling whose solution is binding.

Another mechanism proposed was a resolvency clause - a contractual clause which permits the sovereign to commence a resolvency procedure if it reaches an insolvency state.  The second step would then be a resolvency court led by a permanent president and a limited pool of potential judges who would act if appointed for a particular case. The third step would consist of a set of rules governing the procedures.  This system would then mix contractual innovations with a more statutory approach.

For creditor coordination, ex-ante structures for creditor committees with a governance structure were proposed.

The audience also asked the panelists various questions and the following remarks were made:

The ECB (which purchased Greek bonds, but did not participate in the PSI) and other public banking organizations were hold-outs in the Greek restructuring, when many thought they should have participated in the “pain”, and perhaps the official sector generally should not shield itself from parity of treatment as burden-sharing (on political and economic levels) goes both ways.

Another idea (since some see the weakness more in the official sector response, as opposed to a problem with creditor committee coordination or proposals) was the creation of a Sovereign Debt Forum: an organization with a permanent and neutral staff, whose aim would be to design a collective process to enhance sovereign debt as an asset class.  This independent non-statutory, standing body would identify lessons from past debt restructurings, bridge information asymmetries and facilitate more transparent, predictable and timely treatment of sovereign debt in periods of extreme debt distress.

Perhaps a third alternative to the contractual and statutory approaches may be viable – the judicial one – by class actions (though not possible in the U.K.) or otherwise - to make sure that the sanctity of contract and rule of law is somehow preserved.

Even if the result of all these proposals is a diminution in the amount of hold-outs, one has to think about what sovereigns have had to do to make their restructurings viable, following their defaults with even higher debt-to-GDP ratios.  And, sovereigns have to think about restoring their market access post a restructuring and their continued reliance on private sector funding.

Second Panel on November 5, 2013 

Michael Chamberlin, EMTA’s Executive Director, summarized the official sector’s prevailing view, as discussed by the first panel, that sovereign debt is still too difficult to restructure because of the inability to  bind all creditors, despite the introduction of collective action clauses (CAC’s) into many bond issues.  Restructurings either do not occur, do not occur soon enough or generate enough debt relief and/or leave both debtor and creditors exposed to the continuing claims of hold-out creditors (which, in turn, creates a further incentive for creditors to hold out).  Mr. Chamberlin’s impression of the current views of the official sector and academia is that they range from “the sky is falling” to “some minor tweaks need to be made to improve the existing architecture”.

For well over a decade (and, in fact, going back further than that to the first efforts to distribute sovereign debt more widely throughout the investing community by exchanging bank loans for bonds), members of the official sector, some academics and lawyers representing debtor countries have expressed concerns about perceived difficulties in restructuring sovereign debt.  These concerns have been, in Mr. Chamberlin’s personal view, “overblown”, but they have been exacerbated in recent years by Europe’s credit problems and by the inability of Argentina to move beyond its 2001 default.

A decade ago, the IMF proposed its Sovereign Debt Restructuring Mechanism (or SDRM), which was withdrawn in the face of adverse creditor (and some debtor) criticism, in favor of the (more or less) voluntary introduction of CAC’s that generally permit a super-majority of bondholders (usually 75%) within a series (or issue) of bonds to bind all holders of such series (or issue) to certain fundamental changes of bond terms (notably payment terms, such as principal amount, interest rate or tenor).  The European and Argentine experiences have led to renewed calls, this time joined by some investors, for more effective ways to ensure that all of a debtor country’s bondholders can be bound by a majority or super-majority.

Although so-called statutory approaches (such as the SDRM) appear generally to be off the table, there are still occasional discussions of various statutory mechanisms (such as restrictions on the enforcement of sovereign claims by hold-outs), particularly in the context of Europe.

Specifically, the so-called “improvements” in the sovereign debt architecture that are now being discussed, with proposals expected within the next several months, are two non-statutory approaches, as follows:

(1) Changes in the pari passu clause, ranging from restricting its use to enforce ratable payment, to eliminating it altogether, and

(2) Introducing so-called “aggregation” clauses that would permit a specified percentage of a debtor country’s bondholders to bind all bondholders, rather than the series-by-series or issue-by-issue approach that now applies to most countries.  Recent discussion of the issue of aggregation, which is generally familiar in the domestic US corporate context post-default, has focused on the relative merits of a single vote across all series of a debtor country’s outstanding debt (assuming that the relevant restructuring proposal was “uniformly applicable” to all series) vs. a two-step approach involving a vote across all series coupled with a second series-by-series vote (requiring a lesser percentage) designed to protect the interests of each individual series (while allowing for the possibility that a blocking position could be taken).

While the purpose of EMTA’s panel discussion on October 16 was to describe some of the recent proposals, and the rationales behind them, the November 5 panel was intended to permit some leading market participants to give their reactions to these proposals.

The second panel began by acknowledging that, after ten years, sovereign debt restructuring is back on the international agenda, evidenced by recent reports by various groups, most notably the IMF and a blue ribbon Brookings group.  The thrust is more, earlier and deeper debt relief and a reduction in creditors’ rights, shifting the balance to official sector and issuers leading the charge for change.*

As in the past, the basic concerns are: over-borrowing, over-lending and default; countries and markets underestimating risks; past restructurings being “too little, too late” (although there’s flimsy evidence of that); hold outs and litigation possibly becoming a problem (outside of Argentina); official crisis support should not bailout private creditors; aesthetically, a non-statutory system lacks clarity and is messy-looking; and assertions that debt restructuring is becoming harder (despite empirical evidence to the contrary from Moodys and other bodies).

To summarize the official sector’s recommendations, they are:

(1) achieve more frequent and early debt restructuring, with a move away from a case-by-case, judgment-based approach by the IMF (or the ESM) to a rules-based approach as to when official support will be conditional on a restructuring.  The IMF should signal when the debt sustainability analysis is ambiguous and a “soft restructuring” will be required (which implies no more risky programs (e.g., Brazil, Mexico, Korea, Turkey, Portugal, Ireland, etc.).  The Brooking report supports this, but recommends going even further by suggesting a new version of the SDRM for the IMF and new treaty rules for the EU, creating a fully statutory regime;

(2) reduce the possibility of hold-outs through aggregation clauses (one vs. two-step) that issuers would be forced to include in new issues (even to restructure existing stock), with parallel changes in EU law and the IMF Articles; and

(3) the Sovereign Debt Forum (SDF), a less-unfriendly alternative (recommended by Richard Gitlin) consisting of a formal, but voluntary, forum of all parties, with independent experts, that has to date received little traction; perhaps something less radical will be recommended.

The panel discussed both the underlying assumptions of the official sector’s proposals (e.g., the present system is badly functioning, hold-outs and litigation are serious threats), as well as the reasonableness and workability of the main recommendations.

The following were some of the questions posed to the panelists:

  • What works well and what needs improvement (not just with respect to debt restructuring narrowly, but also a bit more broadly to include avoiding and dealing with debt distress)?
  • With respect to the currently proposed IMF policy for reprofiling and maturity extensions, would this proposal be stabilizing or destabilizing?  Would countries delay even more in coming to the IMF and/or adjusting?  How could “too much, too early” problems be avoided?  Is it good policy to all but abandon the IMF’s traditional fireman’s role?  What other alternatives could the IMF adopt to avoid its own “too little, too late” problem?
  • With respect to the IMF’s lending-into-arrears policy and moving away from creditors’ committees, do committees in practice slow the process (“too late”) or result in less than appropriate debt relief (“too little”)?  Or is the reverse true?  Should recognition and negotiation with a representative committee be presumed if such committee gets organized?  The “good faith” policy, which is included in the IMF’s lending-into-arrears program, does not apply when the restructuring, while part of a IMF program, is pre-arrears, should it?
  • On legal and documentation issues, should the private sector support the broad introduction of aggregation clauses?  Which would be more appropriate -- a two-step test (as used in Uruguay and the EU) or a two-step approach (as discussed in the Brookings report and at the IMF)?  How would the market and issuers react?  Are pari passu clauses an important issue for the markets?  Is it important to standardize the clause?  If so, should standardization refer to pari passu ranking or payments?  Does the market care in the case of future bond issues?  Should strong engagement clauses, requiring issuers to recognize and negotiate with a committee if bondholders vote for one, become part of standard documentation?  If yes, why isn’t the market pushing harder for their implementation?
  • Is the SDF a sensible idea?  Would the market see it as a positive or negative in cases of distress?  How could the experts be neutral in practice?  How could it be put into place?

These questions provoked the following discussion.

Some of the panelists thought that current market-based sovereign debt restructurings are working well enough, with relatively high participation rates, without the need for a total overhaul or even for some of the official sector proposals to be implemented.  The system is not broken (we have come a long way from the 1800’s when restructurings took decades to complete to the Brady era of four to five years to the current completion average of a year, mostly due to CAC’s); what is required is evolution, not revolution.  With additive, incremental steps, the framework for debt restructuring has strengthened over time.  The public sector’s interjection into the restructuring process now is sub-optimal (as evidenced by the times it has intervened with unfavorable results).  However, early engagement by the IMF with soon-to-be failing sovereigns may be advisable.

Those panelists that wanted market-led change remarked on the existing lack of respect for creditors’ rights and issuers who negotiated in bad faith.  Some panelists suggested a middle ground between pure voluntary and statutory solutions - contractual innovation (a move toward a trustee structure), education and discussion were some of the tools suggested.  Other panelists suggested that, while there will always be hold-outs (except in the corporate area of bankruptcy), creditors’ committees (with attendant engagement clauses, which require issuers to pay for creditors’ advisors, regardless of impending default scenarios), acting in their collective interests, are the solution, or at least a powerful tool, to the hold-out problem.  These committees would also help increase the speed, efficiency, professionalism and transparency of the restructuring and bring possible recalcitrant creditors to the table.  Why would the IMF move in the opposite direction of questioning the value of such committees?  And, many panelists stated that there should be “reverse comparable treatment”, such that large institutional lenders (like Central Banks, Paris Club, ECB, European investment banks, etc.) should participate in restructurings and should not hold out (as some have in the recent Greece restructuring).

One panelist suggested that the elimination of all investor protections might prove useful in determining how important the rule of law and enforceability of contract really are to primary and secondary market participants.  Perhaps, the Foreign Sovereign Immunities Act (FSIA) is an experiment that has not worked well for the market as a whole.  Some panelists thought that adding CAC’s, for example, did not affect the pricing of debt issues (and that the importance of CAC’s, a tool  always used in UK law governed contracts, was overstated), others believed that pari passu language modifications may affect pricing and others didn’t think the market was particularly adept at pricing legal risks (until they became real).

Or, maybe looking at primary issue pricing was not dispositive and one had to look at secondary market pricing.  Some didn’t think that the pari passu clause should be standardized (the latest case against Grenada proves that the behavior of the defendant issuer is more important that the precise language or interpretation of that clause).  On engagement clauses, some hoped that the clause would not become another covenant that issuers ignored, while many thought it was a step in the right direction and contributed to improving the process.   

On the SDF, some viewed it as a creditor-friendly approach that encouraged earlier action for all relevant stakeholders, a forum of experts that had experience in consensus–building.  Others viewed the SDF as divorced from reality, and a necessary body without much value, given the implementation problems it would face.

The topic of issuer advisors was raised - perhaps trying to identify destructive advisors was more important than trying to tweak the restructuring process (one legal adviser was said to “advertise his services with billboards that erode creditor rights”).  Also suggested was that the attorneys who helped issuers put their deals together should not be the same attorneys who help those same issuers restructure their debt.

The audience also asked various questions and the following varied remarks were made:

The private sector needs to push back against the official sector’s proposals and their deficiencies, which are much bigger than the private sector’s.  It is better to learn from one’s mistakes than to overhaul the restructuring process by forcing a rescheduling as a condition to obtaining any IMF funds.

In response to a final question about whether the current system worked well for creditors but not for debt countries, several panelists responded by saying that “the current system does work and the official sector is merely using Argentina as a way to move their agenda forward”, “early intervention by the IMF will chase investors away” and “restructurings are not supposed to be easy”.

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* 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.