Crisis Prevention and Resolution: The Role of Sovereign Debt Restructuring, Remarks By Anne Krueger, First Deputy Managing Director, IMF
October 7, 2002Crisis Prevention and Resolution:
The Role of Sovereign Debt Restructuring
By Anne Krueger
First Deputy Managing Director
International Monetary Fund
Remarks at American Enterprise Institute symposium
Washington DC, October 7, 2002
(Revised: October 17, 2002)
Thank you for inviting me to participate on the panel this morning. I agree with the remarks that Glenn Hubbard has just made—as he said, the ultimate goal of our efforts is indeed to promote growth and raise living standards in emerging market economies and in the developing world. The question is: How can we best do so in a world with sizable private capital flows to many of these countries and where private flows now dominate the size of official flows? For the most part, countries able to attract private capital flows are ones with good macroeconomic and structural policies; they are thereby able to manage their debt well and reap the benefits of the foreign capital.
But there are occasions where—through some combination of bad policies and bad luck—countries find themselves with unsustainable debt burdens. Almost invariably in these cases, the country's authorities are reluctant to enter into a restructuring and can delay for several months while value is lost for creditors, the ability to recover is lost for debtors, and ordinary people end up paying a tremendous economic and social cost. Often, uncertainty about how the situation in one country is going to resolve itself affects the value of all developing country debt.
The situation also sometimes leaves the IMF, and—I should add—the institution's political masters, with two unpalatable options: either let the country sink further into a state of crisis or try to assist it with a program when the odds of the program's success have been greatly reduced by the delay in dealing with the debt problem.
This is not a satisfactory state of affairs. Unless the international financial community addresses this problem as part of the efforts to strengthen the framework for crisis prevention and management, it will be difficult for emerging markets to realize sustained growth benefits from foreign capital flows. The IMF's Sovereign Debt Restructuring Mechanism (SDRM) proposal should be viewed in this broader context as part of a package of reforms to improve the IMF's capacity to assist its member countries. We are not proposing the SDRM in isolation, we are not proposing it as a solution to all problems, and we are not pursuing SDRM to the exclusion of other approaches.
A complementary approach to the SDRM is to include collective action clauses (CACs) in all debt contracts. Pursuing this contractual approach in tandem with SDRM would result in a considerable improvement on the current system. The challenge is to foster greater willingness on the part of both debtors and creditors to adopt such clauses in new debt issues. Although the empirical evidence suggests that CACs would not systematically raise borrowing costs, issuing countries have been skeptical about their use, and there is a first mover problem in jurisdictions where CACs are not the market standard. In this regard, I welcome the recent initiative of the EU to lead by example. I am also encouraged by efforts by private market participants to build broad support for the use of clauses in bonds issued under NY law and in other jurisdictions. If these clauses start to become the market standard, this initiative will have a lot of promise. The Fund will continue to support these efforts. We will encourage our members to issue bonds with provisions to facilitate restructurings and we will monitor and publicize the use of CACs by our member countries.
II. Features of SDRM
The aim of the SDRM proposal is to allow countries with clearly unsustainable burdens to restructure their debts in a fashion that preserves economic activity and asset values, while protecting creditors' rights. Markets will work better if there are incentives for early recognition of an emerging problem by both the debtor and the creditor so that the solution that is arrived at is much less painful than it is at present. We want to reduce the cost of restructurings that will need to take place anyway by making the process more predictable and making the legal rules governing the process uniform, but not to increase the likelihood that restructurings will take place. The mechanism does not introduce incentives for countries with sustainable debts to restructure rather than adjust policies. The fear that countries will opt too often for the restructuring option seems unfounded—to the contrary, some of the officials of emerging market countries who have expressed concern about the SDRM proposal have done so on the grounds that it may push them into restructurings they do not want.
The SDRM creates a legal basis for collective action among the sovereign's external creditors. It would allow the debtor and a super-majority of its external creditors to make a restructuring agreement binding on holders of all debt instruments that are subject to the mechanism. It would also allow a super-majority of creditors to vote to provide temporary limitations on the enforcement of creditor claims, and to agree to the provision of new money on a senior basis.
The SDRM shares some features with the contractual approach. Its basic features are modeled on the provisions found in existing sovereign debt contracts governed by English law that allow for collective action among creditors. As with English law bonds, key decisions would be made, as I have mentioned, by the debtor and a super-majority of its creditors, not by a third party (and certainly not by the IMF). Similarly, only the consent of a super-majority of creditors would make a restructuring agreement binding on a minority of holdout creditors. Likewise, creditors would have to certify that negotiations were going forward in good faith for the mechanism to be used.
But SDRM differs from the contractual approach in two keys ways:
- First, the statutory approach would deal with the existing stock of debt, including instruments that do not provide for collective action.
- Second, the votes of creditors holding participating debt instruments would be aggregated, allowing a single vote to restructure multiple debt instruments.
These features would make reaching agreement on a restructuring agreement easier, while still ensuring that any agreement had the support of the vast majority of the sovereign's creditors. Given the diversity of the legal, economic and financial interests of creditors, there would need to be a system that allows for creditors to be put into different classes for voting purposes.
Let me clarify a couple of points that have come up in the discussion today and in earlier forums on the SDRM. First, is the holdout problem a big deal and is the main purpose of the SDRM to get around this problem? The SDRM is not intended to be merely a solution to the holdout problem. It goes much further than that—the hope is that by providing a framework that permits greater ease of identifying and bringing together creditors and greater predictability about the process, the SDRM will increase the incentives for collective action. I agree with Glenn Hubbard that to date the holdout problem has likely not been a very big hindrance. Nevertheless, we should keep in mind that this is not a guarantee that it will remain a small problem in the future. Once some minority creditors have been successful in litigation, the incentives for others may increase. Indeed, there are now reports of litigation to claim full value from some of the HIPC cases, the Democratic Republic of the Congo for instance.
The second clarification is about the role of the Fund once SDRM is in place. The proposal does not envision new legal powers for the IMF. The decisions would be those of the debtor and a supermajority of creditors or of an independent dispute resolution forum. The IMF does not want to—and knows better than to try to—get in the middle of a restructuring discussion by creditors and debtors. But even under the present system, Fund staff observe and are consulted at the time of the restructuring process; there has to be consistency between the Fund's judgments about the sustainable economic program and the feasible size of primary surpluses, on the one hand, and the size of the "haircut" agreed to by the creditors and the debtors, on the other. There are some open issues as to the timing of such consultations with the Fund once the SDRM is in place. But, in broad terms, the Fund's role will continue to be what it is today, namely that of signaling its willingness to support a country's economic policies and providing financial assistance through an IMF-supported program.
III. Next Steps
While these are the basic elements of SDRM, many detailed features of the design of an operational SDRM need to be worked out. Some of these features were discussed by the IMF's Board in a preliminary fashion last month:
- With respect to the scope of debt to be covered by the SDRM, as a first cut our intention is that the SDRM should include only those claims held by private creditors that are either governed by foreign law or subject to the jurisdiction of foreign courts.
- The design of the SDRM should retain flexibility, given the potential complexity and diversity of instruments and creditors involved in individual restructurings. The establishment of a classification system whereby claims are aggregated within-but not across-classes for voting purposes would allow for the aggregated voting needed to facilitate restructurings, while still protecting the specific interests of a set of creditors holding certain types of claims.
As I mentioned at the outset, the SDRM is one component in a package of reforms to improve the IMF's ability to better assist its member countries in crisis prevention and resolution. Work on the SDRM has to go hand-in-hand with several other reforms including:
- Increasing the Fund's capacity to assess better the sustainability of a member country's debt;
- Defining better the policy for exceptional access to Fund resources, to help improve the quality of decision-making by country authorities and financial market participants;
- Clarifying the policy governing Fund lending into sovereign arrears to private creditors, so that it supports sound adjustment policies and encourages collaborative agreements with creditors.
We intend to maintain our dialogue with the private sector, emerging market sovereign borrowers, and the public as we go about these reforms. Drawing on these discussions, the IMF staff will further refine its analysis and outline the elements of a fully elaborated proposal for an SDRM for consideration at the time of our Spring Meetings next April.