IMF Executive Board Discusses Strengthening the Contractual Framework in Sovereign Debt RestructuringPress Release No.14/459
October 6, 2014
On October 1, 2014, the Executive Board of the International Monetary Fund (IMF) discussed the staff paper “Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring.”
The staff paper follows up on the Executive Board’s guidance to Fund staff in May 2013, which stemmed from an earlier staff paper: “Sovereign Debt Restructurings–Recent Developments and Implications for the Fund’s Legal and Policy Framework.” That paper reviewed the recent application of Fund policies and practices on sovereign debt restructuring and identified a number of issues for further in-depth study. The Executive Board agreed in May 2013 that these issues required follow-up work and asked staff to present options for reforming the Fund’s policy framework in each of the following areas: (i) the relationship between the Fund’s lending framework and sovereign debt vulnerabilities; (ii) the effectiveness of the contractual, market-based approach to debt restructuring in overcoming collective action problems; (iii) the framework for official sector involvement; and (iv) the lending-into-arrears policy.
The latest staff paper focuses on contractual reforms designed to address collective action problems so as to achieve orderly sovereign debt restructurings, particularly in light of recent developments. The proposed reforms reflect extensive consultation over an 18-month period with issuers and market participants, including with the International Capital Market Association. First, the staff paper proposes a modification to the pari passu clause in international sovereign bonds to make clear that it does not require the issuer to pay creditors on an equal or ratable basis. Second, the paper discusses the inclusion of an enhanced collective action clause (CAC) that includes a more robust “aggregation” feature to address collective action problems more effectively. Third, the paper considers the role that the Fund can play in promoting the use of these modified provisions in future issuances of international sovereign bonds, while noting the transitional risks created by the existing stock of bonds that do not contain such modified provisions.
Executive Board Assessment
Executive Directors welcomed the opportunity to discuss proposed reforms to the contractual framework for international sovereign bonds, which is one of the work streams in the area of sovereign debt restructuring previously endorsed by the Executive Board. Directors noted that these work streams—which include the ongoing work on reforms to the Fund’s lending framework in the context of sovereign debt vulnerabilities, the framework for official sector involvement, and the Fund’s lending-into-arrears policy—are intended to contribute to the overall objectives of facilitating timely and orderly sovereign debt restructurings, where restructurings are deemed necessary, and reducing the overall costs to the system. They looked forward to further discussions in these areas.
Directors recognized that recent developments, including the Argentine litigation in the U.S. courts, underscore the importance of further strengthening the existing contractual framework. They appreciated staff efforts to consult closely with a broad range of stakeholders, including the International Capital Markets Association, which has recently published model contractual clauses (ICMA Clauses) that take into account the conclusions of these consultations. Directors agreed that, since any decision regarding the design and use of contractual provisions will need to be made by the sovereign issuer and its creditors, the Fund’s primary role will be to facilitate agreement on the design of such provisions and promote their use in an advisory capacity.
Pari Passu Clause
Directors acknowledged that the recent New York court decisions with respect to Argentina may exacerbate collective action problems, although most felt that the extent of their impact on the restructuring process is still unclear. Directors welcomed the recent modification of pari passu clauses in certain sovereign bond issuances to explicitly exclude the obligation to effect ratable payments. Accordingly, they supported the widespread use of these types of modified pari passu clauses in new international sovereign bonds so as to enhance legal certainty and consistency across jurisdictions.
Collective Action Clause (CAC)
Directors noted the broad support of stakeholders for introducing CACs with robust aggregation features. Specifically, they considered a “single-limb” voting procedure that will enable bonds to be restructured on the basis of a single vote across all affected instruments to be an effective tool to limit the ability of holdouts to undermine the restructuring process. Directors agreed that, as a safeguard to protect the interests of creditors where such a procedure is used, the CAC should require all affected bondholders to be offered the same instrument or an identical menu of instruments, and include a voting threshold of 75 percent of the aggregated outstanding principal of all affected series.
Directors emphasized that the CAC should be flexible enough to allow for differentiation among creditors where appropriate. For this reason, they supported the inclusion in new international sovereign bonds of a single CAC with a menu of voting procedures, including: (a) a single-limb voting procedure with the possibility for “sub-aggregation” (that is, the ability to conduct separate votes for different groups of bond issuances); (b) a two-limb aggregated voting procedure; and (c) a series-by-series voting procedure.
Directors concurred that the CAC should accommodate a broad range of debt instruments, including bonds denominated in different currencies and governed by different foreign laws. While recognizing that there may be benefits in including a CAC with an aggregated voting procedure in bonds governed by domestic law, Directors generally stressed that the priority of the Fund should be to promote inclusion in foreign law-governed bonds, given that these bonds give potential holdouts the greatest amount of legal leverage.
Directors noted that bonds issued by euro area sovereigns are required to include a CAC that allows for either a series-by-series voting procedure or a two-limb voting procedure. Taking into account the fact that bond issuances by euro area sovereigns are, in most cases, governed by domestic law, and that this type of CAC has been positively received by market participants over recent years, Directors considered that this approach is appropriate for such bonds.
With respect to other key design features, Directors generally agreed that, as a means of addressing concerns regarding potential manipulation of the voting process, the CAC should include robust disenfranchisement provisions consistent with those generally found in international sovereign bonds. Directors also endorsed an approach where the relevant documentation is transparent regarding both the design of the CAC and the scope of debt it will cover. Finally, if requested by creditors, the CAC should include information covenants that are consistent with Fund policy.
Promoting Contractual Reform and Navigating the Transition
Directors supported an active role for the Fund in promoting the inclusion of enhanced contractual provisions in new international sovereign bond issuances, and endorsed the three-pronged approach outlined in the staff paper. However, they noted that it would take time for the significant stock of outstanding international sovereign bonds to mature, posing a risk to orderly restructurings, although the magnitude of such risk remains uncertain. They encouraged staff to engage in further discussions with stakeholders on ways to minimize this risk. Directors looked forward to periodic progress reports on the status of inclusion of the proposed contractual provisions in international sovereign bonds