Sovereign Debt Restructuring and Dispute Resolution -- Speech by Anne Krueger, First Deputy Managing Director, IMF
June 6, 2002
First Deputy Managing Director
International Monetary Fund
Bretton Woods Committee Annual Meeting
Washington DC, June 6, 2002
Mr Chairman. Ladies and Gentlemen.
It is a great pleasure to be here today, to be speaking alongside my colleague John Taylor and in the presence of this distinguished audience. The Bretton Woods Committee has long played a vital role, supporting the principle of international cooperation in the global monetary and financial arenas, and helping to ensure that there is informed debate here in the US on the key policy issues of the day.
What I would like to do today is to bring you briefly up to speed with progress on the two-track approach to improving sovereign debt restructuring that was endorsed by the US and the rest of the international community at our recent spring meetings.
The first track involves more ambitious use of collective action clauses in sovereign bond contracts. The second – and complementary – track involves creating a statutory mechanism that we believe that can help secure more orderly and timely restructuring of unsustainable sovereign debts by empowering a super-majority of creditors to take key decisions in the restructuring process in negotiation with the debtor.
A key challenge that confronts both approaches is the coordination of a diffuse and diverse creditor base, with different creditors able to seek enforcement of their rights in different legal jurisdictions. Dealing with this issue when relying entirely on collective action clauses is very difficult. But within the statutory approach, we believe that it is possible to resolve this coordination problem through the creation of a framework that would aggregate claims across instruments for voting purposes, while paying due regard to the seniority of certain creditors and, more generally, to creditors' varying economic interests.
A framework that provides for such aggregation would require the establishment of a dispute resolution forum that would enjoy limited but exclusive powers for the orderly conduct of the restructuring process, including the resolution of disputes between a sovereign debtor and its creditors, on the one hand, and amongst creditors, on the other hand. Some commentators have expressed fears that the creation of such a forum might be a back-door way for the Fund to exert a malign influence over the restructuring process. That is not the case, so I will focus in my remarks today on how such a forum might be set up and operate.
But let me first begin with a general introduction to progress so far.
2. The Two-Track Approach
Our discussions to date reveal widespread agreement on our basic diagnosis: that we lack adequate incentives for orderly and timely restructuring of unsustainable sovereign debts. This can impose unnecessarily heavy economic costs on debtor countries; it can undermine the value of creditor claims; and it can leave the international community confronting an unpalatable choice between a disruptive unilateral default or bailing out private creditors and contributing to moral hazard.
The problem in large part reflects the way that international capital markets have evolved over the last two decades or so. Capital markets have become more integrated and there has been a shift from syndicated bank loans to bond issues. As a result, sovereign borrowers increasingly issue debt in a range of legal jurisdictions, using a variety of instruments, to a diverse and diffuse group of creditors.
This has widened the sources of finance available to emerging market countries. But at the cost of increased problems of coordination, collective action, and inter-creditor equity when debts have to be restructured. In consequence, necessary restructuring has become much more difficult and less predictable than it was in the 1980s. Our goal is not to make default an easy way out., but rather to create better incentives for timely and orderly restructuring while protecting asset values and creditors' rights.
The key to improving the current system is to allow a super-majority of creditors – across a broad range of instruments – to make the terms of a restructuring binding on the rest. This should help secure restructuring prior to default. But, in case this proves impossible, the new approach would also need to do the following:
- First, to give the debtor legal protection from creditors while negotiating;
- Second, to give the creditor assurances that the debtor will negotiate in good faith and pursue policies that protect asset values and restore growth, and;
- Third, to guarantee that fresh private lending would not be restructured.
Finally, you also need a way to verify claims, oversee voting, and adjudicate disputes.
These are familiar features from domestic bankruptcy regimes. The parallel should come as no surprise. As Adam Smith wrote in 1776: "When it becomes necessary for a state to declare itself bankrupt, in the same manner as when it becomes necessary for an individual to do so, a fair, open and avowed bankruptcy is always the measure which is both least dishonorable to the debtor, and least hurtful to the creditor."
Use of the mechanism would be for the debtor to request, and not for the Fund or anyone else to impose. As I mentioned earlier, in common with domestic bankruptcy regimes, the existence of a predictable framework should in most cases be sufficient to encourage voluntary agreement "in the shadow of the law", without formal activation.
Collective action clauses – typical of bonds issued under English law – are one way to provide the key features of the new approach. This is our first track. But they have important drawbacks. To begin with, they only bind holders of a single bond issue. If CACs are to facilitate comprehensive restructuring – which is what would be required – then they need to be adapted to aggregate across all claims, including banks.
But such "super collective action clauses" are problematic for three reasons:
- First, how do you persuade creditors and debtors to issue new debt and exchange existing debt for bonds that include these clauses, when they are already reluctant to include ordinary CACs? One suggestion has been to make this a condition of access to Fund lending. But this would be the time at which the private sector is most reluctant to lend and when the debtor may be most reluctant to signal a greater chance of default by adopting them.
- A second problem is that emerging market sovereigns typically borrow in several legal jurisdictions. Not even identical restructuring language in CACs would necessarily guarantee uniform interpretation or application.
- Third, the current domestic laws of some of our members do not provide a clear statutory basis that allows the rights of minority creditors to be modified without their consent.
We are working on ways to tackle these drawbacks, but in the end I am sure that we will need a statutory underpinning for the new approach as well. Hence the second track.
The statutory approach would use a treaty obligation – probably achieved through an Amendment of the IMF's Articles of Agreement – to empower a super-majority of creditors to reach agreement with the debtor and bind in the rest. This would resolve the problem posed by different legal jurisdictions, as the treaty obligation would provide for legal uniformity in all jurisdictions. Moreover, the establishment of a single and exclusive dispute resolution forum would ensure uniform interpretation.
But I should emphasize that an amendment of the articles would be used only as a tool to empower the creditors and debtor, not as a way to extend the IMF's legal authority. The Fund would only influence the process as it does now, through its normal lending decisions.
As we continue to develop this two track approach, we are working on a number of questions. For example:
- How should the member's initial request for a stay be dealt with, given the time it would take for creditors to be in a position to vote?
- How should Paris Club debt be treated in the restructuring process?
- How should we treat sovereign debt owed to domestic creditors?
- How can we promote a collaborative interaction between debtors and creditors, rather than the use of take-it-or-leave-it exchange offers?
- Should we extend legal protection to viable firms prevented from servicing their debts by the imposition of exchange controls?
And then there is the question of how best to secure the verification of claims and adjudication of disputes. It is this I will focus on in the rest of my remarks.
3. Dispute Resolution under a Sovereign Debt Restructuring Mechanism
For the new approach to sovereign debt restructuring to enjoy credibility and legitimacy, it will need to have the capacity to resolve disputes among creditors – and between creditors and the debtor – in a way that is demonstrably fair to all parties.
This role could not therefore be played by the Executive Board of the IMF. Not only do Executive Directors lack the necessary expertise, but their decisions could be thought to be influenced by the Fund's role as a creditor and by the representation of the debtor and bilateral creditors on the Board. Indeed, the dispute resolution forum should operate – and been seen to operate – independently not only of the Executive Board, but also of the governors, management and staff of the IMF. The flipside of this independence is that the role of the dispute resolution forum should be strictly limited.
Our thinking on the dispute resolution forum is far from complete, but let me describe briefly what shape we think it could take. I will deal in turn with three aspects: the powers of the forum; its composition, and; the legal status of its decisions.
The first set of powers that the forum would need to exercise would be the administration of creditor claims. This is a purely administrative function, similar to what a domestic bankruptcy court would do. This would involve notifying creditors that the debtor had requested activation of the mechanism; identifying the claims submitted by creditors; and publicizing dates, places and procedures for voting.
The forum would also administer the voting process, organizing the meetings at which it took place and the recording of votes cast. More ambitiously, the forum – or, indeed, a separate private institution – could also be given responsibility for administering a permanent sovereign claims registry. Registration would be voluntary, but participation could well come to be seen as part and parcel of prudent debt management. It would certainly make creditor coordination much easier in the event of a crisis.
The second set of powers would be the resolution of disputes among the creditors, or between creditors and the debtor. Disputes would likely arise in two main areas:
- First, verification of claims. Creditors may be concerned about the creation of fictitious claims that could be used to manipulate the voting process. There may also be disputes regarding the value of claims and the collateral that secures them.
- Second, integrity of the voting process. If claims are to be aggregated across instruments for voting purposes, ensuring integrity of the voting will be of critical importance. Even if all the claims are bona fide, there might still be a perceived risk of collusion between the debtor and certain creditors in the voting process. For example, some creditors could be offered undisclosed financial incentives to vote in a particular way. Creditors may also be concerned that the sovereign might try more subtle forms of influence, for example using its regulatory powers to put pressure on domestic creditors subject to government regulation or control. The statute setting up the mechanism would need to include rules to safeguard against these abuses. The dispute resolution forum would be charged to adjudicate their interpretation and application.
This would be the limit of the forum's powers. It would have no authority to challenge decisions by the Executive Board of the Fund, for example regarding the adequacy of the members' policies or the sustainability of the member's debt. Just as importantly, it would have no authority to override the decisions of a qualified majority of creditors on such issues as the terms of a restructuring plan or the length of a stay. Its role would be essentially reactive. For example, although the forum could resolve disputes regarding the application of creditor classification rules, it would not itself be responsible for classifying creditors in the first place.
Now let me turn to the possible composition of the dispute resolution forum. In order to command the credibility and legitimacy necessary to carry out its functions effectively, the setting-up and operation of the dispute resolution forum would have to be guided by four basic principles: independence, competence, diversity and impartiality. These principles could be achieved through a five step process:
- Step One: Each of the IMF's 183 members would have the right to nominate one candidate, who need not be a national of the nominating country. Such a large pool would guarantee diversity of geography, legal tradition and professional experience, as well as making it possible to ensure the inclusion of members from both debtor and creditor countries. Soliciting nominations from members directly rather than from the Executive Board would also help ensure independence from the Fund.
- Step Two: An independent and qualified committee of eminent persons could be established by the Executive Board to vet the nominees and recommend a list of, perhaps, 21 for selection to the forum. The committee could be guided by the advice of independent, international professional associations that are expert in insolvency and debt restructuring, for example the International Federation of Insolvency Professionals, the International Bar Association's Committee J, and the International Insolvency Institute. It could also consult with representative associations of private creditors . The private creditors we have spoken to say that they would prefer the members of the dispute resolution forum to be practicing judges experienced in debt restructuring, but membership could also be open to retired judges, academics or practitioners.
- Step Three: The names recommended by the committee could then be passed to the Board of Governors for approval. They would have to vote on the entire list as a package. If it was rejected the process would have to start again. Following approval by the Governors, the Managing Director could then appoint each member of the forum for a renewable term of four or five years.
- Step Four: The appointed members of the dispute resolution forum would then elect a Presiding Member from among their own number, with specified duties to oversee the functions and operation of the forum. It is important to emphasize that none of the members would be full-time employees of the forum. They would continue to work as normal in their own countries unless they were impaneled for a particular case.
- In the fifth and final step, when an actual case was submitted to the forum, three members would be impaneled by the Presiding Member. The Presiding Member would take good care to ensure that members with conflicts of interest in specific cases were not permitted to serve on them. The Presiding Member could also set up a committee to draft the procedural rules of the forum, which would then have to be approved by the forum as a whole.
We believe that a process of this sort would provide the guarantees of independence, expertise, diversity and impartiality that the dispute resolution forum would require to secure the necessary credibility and legitimacy. There are of course other questions of powers and composition that would have to be dealt with.
Legal Status of Certain Decisions
In addition to resolving disputes, the dispute resolution forum would certify key decisions made by the debtor and a super-majority of creditors, including with respect to the final restructuring terms and the stay. These certifications of the dispute resolution forum would need a legal status making them binding on all member countries. In other words, they would need to be treated as though they were decisions of each member country's national courts. This means that each member of the Fund would need to comply with the forum's certifications and give effect to them in its territory – whether or not the member was a party to the particular case in question. The debtor or creditors would notify particular domestic courts or other authorities of a certification as and when it became necessary for them to enforce their rights.
It should be emphasized, however, that certifications would be based exclusively on the decisions made by a qualified majority of creditors. The dispute resolution forum would, in effect, only be certifying that the vote of the creditors had taken place in accordance with the procedural requirements and that there had been no evidence of fraud. The certification would not be based on the exercise of a dispute resolution panel's discretion.
To conclude, let me say that I understand that all countries – and, perhaps, this one in particular – are reluctant to cede or share their sovereignty over decisions that are important to their citizens to international forums. But if we have learnt one thing from the turmoil that many emerging market economies have been through in recent years, it is that the health and stability of the global financial system cannot be secured by a single nation working alone. International cooperation is essential to ensure that the system works as smoothly as it can, otherwise we all bear the costs.
In a world in which sovereign borrowers have diffuse and diverse creditor bases, we need a way to overcome the coordination and collective action problems that stand in the way of timely and efficient restructuring. For both the contractual and statutory approaches, that means addressing the problems created by the diversity of legal jurisdictions in which creditors can seek repayment. We believe that a dispute resolution forum – small in size, limited in role, and demonstrably independent in its membership and operation – is the best way to achieve this. To help avoid chaotic defaults or expensive bailouts in the future, that is surely a price worth paying.