Gaps in the Architecture

1

• Gaps in the Architecture
• for
• Sovereign Debt Restructuring
• Benu Schneider

The views expressed do not necessarily represent
those of the Financing for Development Office,
Department of Economic and Social Affairs, UN
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Identifying Gaps in the IMF Architecture for
Debt Resolution in a world of open capital
accounts
Standstills
Adjustment
New Financing
Domestic Policies adjustment thru exchange
rate
IMF
Article VII 2b for Current Transfers
Debtor-in-Possession Financing by the Private
Sector
Provision for Standstills for Capital Accounts
Transfers
Adjustment through Debt-Restructuring
Lack of a rules-based platform for engagement of
debtors and creditors, creditor coordination,
independent DSAs, Debt Restructuring and No
formal platform for the engagement between the
private and public sector
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Fragmentation
Debt to Multilaterals
Debt to official creditors
Debt to commercial Banks
Bond debt
Yes, London Club
No, it cannot be restructured except for HIPC
countries
Yes, at the Paris Club The terms of treatment
are determined on the basis of per capita and
debt ratios (require bilateral agreements
after Paris Club agreements) Covers only PC
members
Yes, with and without collective action clauses
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What would the SDRM1 have done?

• Creditor committees / Voting thresholds
• Priority financing
• Restructuring agreement
• Sovereign debt dispute resolution forum
• Type of debt to be treated, verification,
  comprehensiveness
• Stays by majority rule
• Sanctions

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Gaps in architecture

• Lack of a centralized dispute resolution
  mechanism
• Lack of organized representation of all
  stakeholders
• Lack of enforceable priority rules for creditors
• Problems with inter-creditor equity and equity
  between the private and public sector
• No international law governing international
  bankruptcies judgments passed in one
  jurisdiction is not enforceable in another
  jurisdiction legal diff across jurisdictions
• No provisions for standstills that provide
  breathing space.
• Independent DSAs
• Legal gaps Vulture fund litigation

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Concerns

• Creditors
• Erosion of creditor rights
• Willingness to pay potentially capricious
  behavior by some debtors
• Impacted by preferred creditor status

• Debtors
• Undue lags
• Insufficient debt relief leading to future debt
  restructurings
• Jeopardy to resumption of growth and debt
  sustainability, impact on trade, FDI etc.
• Hold outs, litigation
• Access to finance and the cost of finance

Non-system implications for global financial
stability
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Contractual discussion a step forward but only
on bonds missing other loan contracts

• To be recognized that efficacy of CACs is limited
• Contractual terms cannot take on the role of
  public policy such as externalities, societal
  distribution problems and broad equity terms for
  stakeholders
• Market based approach needs further work on
  process questions, standstills, safety clauses

8
Aggregation

• Problem of existing stock
• Voluntary even after years may not have bonds
  issued with the new clauses
• Underlying assumption that no single investor
  has the scale of resources to block a
  restructuring plan but easy for example in the
  case of bonds issued by frontier markets or when
  some hedge funds form a single firm to prevent a
  restruct. plan

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Jurisdiction issues

• Judgment passed in one jurisdiction are not
  enforceable in other jurisdictions
• Lack of coordination between different courts and
  the WBs ICSID
• All litigation cannot be settled under one
  umbrella, ensure inter-creditor equity
• The lack of coordination has high human and
  financial costs for debtors
• They result in delay high costs- lack of access
  to markets

10

• Litigation in sovereign debt defaults is more
  common than the general perception
• In recent times 50 of debt crises involved
  legal disputes affecting 25 countries(data base
  covers US and UK).
• Increasing strength of holdout creditors
  -Argentine case is part of a general trend
• Distressed debt funds involved in 75 of cases
• Shumacher, Trebesch anf Enderline Sovereign
  Defaults in Court (May 2014)

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Creditor returns high in litigation cases

• Lack of systematic work but in the past known to
  be high
• 400 for Elliot in Peru
• Elliot 60 in Panama
• Cardinal Financial Inv. 270 in Yemen
• Litigation is associated with
• loss of market access
• loss in int. trade
• delays in crisis resolution
• Externalities larger than the amounts under
  litigation

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Implications of the Argentine Debt Litigation

• Consensus that this is game changer will impact
  future debt restructurings by strengthening the
  hands of holdout creditors illustrates the
  legal gaps in architecture
• Support improvement in contractual technology but
  something else is needed in addition moreover
  there is still the problem of the existing debt
  stock voluntarity

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Diversity in debt restructurings

• Those without nominal haircuts move rapidly,
  fewer holdouts, but need multiple restructurings.
  Costly in the long run for both debtors and
  creditors. For deeper haircuts negotiations are
  protracted.
• A large no. of voluntary and light
  restructurings, as the fall-back position has
  been protracted legal processes characterized by
  uncertainty.
• Deeper haircuts - creditor cajoling,

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Costs of sovereign debt restructurings
Output losses Around 5 per cent a year, Up to 10 years. Higher if twin or triple crises
Trade losses Falls bilaterally by about 7 percent per year, average 15 years
Decreased access to external credit Drop in private sector access of up to 40 per cent in the year after
Higher spreads Greater haircuts larger post-restructuring bond spreads until 6-7 years after Also highly correlated with duration of capital market exclusion
Financial instability Loss of value of restructured assets, deposit withdrawals and interruption of interbank credit lines, interest rate hikes
Lower FDI Drop in flows of up to 2 of GDP per year
Lower credit ratings After 1 year most sovereign bonds C- rating
IMF 2012, Sovereign debt restructurings
1950-2010 Literature survey, data and stylized
facts
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Delay Different criteria between official and
private sector

• For the private sector delay means once the
  process is initiated, how long it takes reach a
  settlement in the negotiation
• For the official sector delay has two parts
• Delay in initiating a debt restructuring
• Once initiated, the time it takes to reach a
  settlement

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• Delay gives vulture funds the opportunity to
  purchase debt at a discount and then holdout for
  high gains

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Meet the gap in architecture

• The IMF plays a unique role in assisting its
  members to strike a judicious balance between
  financing and adjustment
• but
• it runs the risk of being less effective in this
  role due to the absence of a framework for timely
  and orderly debt restructuring

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Moral hazard of IMF lending to both debtors and
creditors

• Debtors defer needed adjustments hoping for an
  improvement in economic conditions
• Lenders do not correctly price in risk
• Banks may postpone recognizing losses on their
  balance sheets

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Evolution of policy of lending into arrears

• 1970 intolerant of arrears (arising due to
  foreign exchange restrictions) restructuring
  considered harmful arrears to be eliminated
  during the duration of the fund program
• 1980relaxation of the requirement that the
  arrears had to be cleared during the duration of
  a funds program
• Possible need for elimination of arrears thru
  debt renegotiation (but not how)

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1980s Debt Crisis

• IMF - three principles
• protect its own resources
• became an advocate of burden sharing
• IMFs preferred creditor status
• IMF did not lend money till arrears with private
  creditors were cleared either thru rescheduling
  or new money or both (forced debtors to agree
  terms set by private creditors) no arrears policy
  put the IMF at risk not to lend at all

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Lending into arrears (contd)

• 1989 arrears policy modified to tolerate temp
  arrears to commercial banks even if no agreement
  on debt renegotiation had been reached (no
  tolerance of arrears to PC creditors who were
  60.67 percent of IMF ex board)
• 1998 good faith negotiation
• 1999 good faith effort to reach a collaborative
  agreement with its creditors

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• 2002 good faith criterion elaborated into a
  full-blown set of prescriptions and procedures
• Gave grounds for intense lobbying by the private
  sector (but nothing in its arsenal over
  jurisdiction over private sector)
• IMF arbiter and referee of good behaviour and
  good faith
• After Asian fin crisis policy of exceptional
  access (post Greece, amendment of policy)

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Lack of a credible exit strategy

• Sometimes the lack of an acceptable alternative
  in terms of an orderly exit gives the IMF little
  choice but to exercise forbearance and continue
  disbursements even in cases where, on the balance
  of probabilities, an inter-temporal solvency
  condition may be violated.