## _042613 ## Source details **Canonical URL:** [_042613](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042613.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042613.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042613.pdf.json) --- ### Executive summary — recent developments and purpose - Greece launched the largest sovereign debt restructuring in history in February 2012 covering EUR 205 billion in debt. - Other recent restructurings or related actions: Belize (2007, 2013), Jamaica (2010, 2013), St. Kitts and Nevis (2012), and Grenada (announced intention to restructure public debt). - Ongoing litigation against Argentina could increase leverage of holdout creditors. - The Institute for International Finance (IIF) issued an annex to its Principles in light of the Greek restructuring experience. - Paper scope: - Recaps Fund legal and policy framework for sovereign debt restructuring: debt sustainability, market access, financing assurances, arrears, private sector involvement (PSI), official sector involvement (OSI), use of legal instruments. - Reviews application in Fund-supported programs and highlights issues from recent restructurings. - Describes recent initiatives in other fora and highlights differences with Fund framework. - Identifies issues for further staff follow-up to assess possible adaptations of the Fund’s framework. ### Key findings and high-level issues - Restructurings have often been "too little and too late"—failing to re-establish debt sustainability and market access durably. - Possible responses identified: - (i) increased rigor and transparency of debt sustainability and market access assessments; - (ii) exploring ways to prevent use of Fund resources to bail out private creditors; - (iii) measures to alleviate costs associated with restructurings. - The contractual, market-based approach is becoming less potent in overcoming collective action problems, especially in pre-default cases. - Consider introducing more robust aggregation clauses into international sovereign bonds, while addressing inter-creditor equity concerns. - Consider conditioning Fund financing more tightly on resolution of collective action problems. - Growing role and changing composition of official lending call for a clearer framework for official sector involvement, especially regarding non-Paris Club creditors and modalities for securing financing commitments. - The collaborative, good-faith approach embedded in the Lending into Arrears (LIA) policy remains promising to regain market access post-default; review of LIA effectiveness and possible extension to official arrears is warranted. ### Recommended next steps - Four areas for in-depth staff analysis: - (i) addressing restructurings that have been too little and too late; - (ii) strengthening tools to overcome collective action problems within the contractual, market-based approach; - (iii) clarifying the framework for official sector involvement given changing composition of official lending; - (iv) reviewing the effectiveness of the LIA policy and considering its extension to official arrears. ### The Fund’s lending mandate and operational considerations - Fund lending mandate: assist members in resolving balance of payments problems within a timeframe for medium-term viability and repayment to the Fund. - In many programs Fund financing catalyzes spontaneous external private financing and sometimes official financing. - Where members with significant external indebtedness have lost or are losing market access: - financing needs may exceed the Fund’s financing capacity and the member’s adjustment capacity; - the Fund requires adequate financing assurances from other sources to fill residual gaps during and after the program; - the Fund’s financing assurances policy explicitly encourages “the restructuring of creditors’ claims on the country on terms compatible with balance of payments viability” when gaps cannot be filled. - Distinction between illiquidity and solvency: - Illiquidity cases: typically require rescheduling of maturing obligations if good prospects for market access restoration exist. - Solvency cases: may require reduction in the debt stock. - Rapid restructuring is beneficial; delays exacerbate indebtedness, economic dislocation, financial instability, and moral hazard and burden-sharing problems. --- ### Debt sustainability, exceptional access, and market access - Debt sustainability is a prerequisite for external viability, program success, and Fund safeguards. - Exceptional access policy historically required a “high probability” that debt is sustainable in the medium term; in May 2010 an exception was added where “there is a high risk of international systemic spillovers.” - Market access criterion: the member must have prospects of (re)gaining access to private capital markets within the timeframe when Fund resources are outstanding. - DSA framework: - Provides examination of debt structure, projections for debt-burden indicators in baseline, alternative, and stress scenarios, and medium-term coverage (generally understood as five years). - Debt sustainability judgments require that the primary balance needed to stabilize debt under baseline and realistic shock scenarios is credible and that debt level is consistent with acceptably low rollover risk and preservation of potential growth. - If the Fund determines debt is unsustainable and restructuring is initiated, the Fund must judge the envisaged restructuring: - (i) makes the debt sustainable, and - (ii) is likely to attract sufficient creditor participation and avoid disruptive legal challenges. ### Preemptive restructurings and Lending into Arrears (LIA) - Fund encourages collaborative engagement and avoiding default where possible; members should seek “preemptive” restructurings and continue servicing original claims during restructuring. - LIA applies to: - (i) sovereign arrears to external private creditors, and - (ii) nonsovereign arrears to external private creditors from exchange controls. - Under LIA the Fund may lend to a member in sovereign arrears to external private creditors only where: - (i) prompt Fund support is essential for program success, and - (ii) the member is pursuing appropriate policies and making a “good faith effort” to reach a collaborative agreement with private creditors. - Where an organized negotiating framework exists and creditors have formed a representative creditors committee, the sovereign is expected to enter into good faith negotiations with that committee. - Private creditors should not have a veto over the design of the financing plan or the adjustment program. --- ### Restructurings that are "too little and too late" — findings and country examples - Recent experience: unsustainable debt situations often fester before resolution; restructurings do not always restore sustainability and market access durably, leading to repeated restructurings. - Pressures to delay restructurings stem from: - authorities’ concerns about financial stability and contagion; - official creditors’ incentives to accept sanguine assessments of sustainability and market reaccess; - private creditors’ preference for official bailouts to avoid restructuring. - Empirical examples where staff assessed unsustainability well before restructuring: - Belize: staff noted concerns in the 2005 Article IV consultation; restructuring occurred in 2007 (outside a Fund-supported program). - Seychelles: staff noted unsustainable debt as early as the 2003 Article IV report; default in 2008 and restructuring in 2009–10 after Fund assistance sought. - St. Kitts and Nevis: DSAs from as far back as 2006 showed explosive debt path; government announced intention to restructure only in 2011 in the context of a new Fund-supported program. - Greece: early restructuring was difficult despite sustained loss of market access due to availability of official financing and an initial willingness to undertake unprecedented fiscal adjustment; private debt restructuring was launched in February 2012 after planned adjustment proved unfeasible. ### Characteristics and outcomes of recent restructurings (selected exact figures) - Face-value haircuts were substantive only in Argentina, Ecuador, Greece, Seychelles, and St. Kitts and Nevis (ranging from 30 to 70 percent). - Some restructurings relied on NPV reductions via maturity extensions and below-market rates; achieved debt relief is sensitive to discount rate choice. - Table 1 case excerpts (figures preserved from source): - Argentina (Dom./Ext. Bonds): Post-Default, Default Date Jan-02; Total Duration (Months) 21; Debt Exchanged in US$ bn 81.80; Cut in Face Value 43.4%. - Greece (Dom./Ext. Bonds): Preemptive, Preemptive Default Date Jul-11; Total Duration (Months) 8; Debt Exchanged in US$ bn 271.22; Cut in Face Value 53.5%. - Seychelles (Ext. Bonds/Loans): Post-Default, Default Date Jul-08; Total Duration (Months) 11; Debt Exchanged in US$ bn 0.32; Cut in Face Value 50.0%. - St. Kitts and Nevis (Bonds/Loans): Preemptive, Default Date Jun-11; Total Duration (Months) 10; Debt Exchanged in US$ bn 0.14; Cut in Face Value 31.8%. - Jamaica (Dom. Bonds) 2010 restructuring: addressed debt level of 124 percent of GDP with a flow rescheduling and no principal haircut. - Multiple restructurings were common: five of nine studied cases (Argentina, Belize, Greece, Grenada, Jamaica) experienced two or more restructurings of private and/or official claims. - Cases that convincingly restored sustainability: - Seychelles: 45 percent haircut (nominal) on official debt and 50 percent haircut on private bondholders with 100 percent participation reduced public debt from about 130 percent of GDP at end-2008 to 78 percent at end-2012. - St. Kitts and Nevis: bond exchange with a haircut of 50 percent in NPV terms and a debt-land swap helped reduce public debt from about 154 percent of GDP at end-2011 to 92 percent at end-2012. ### Policy implications from timing and contagion considerations - Allowing unsustainable debt to persist imposes costs on debtors, creditors, and the Fund. - Contagion concerns can be legitimate, but should not override the primary duty to help members resolve balance of payments problems. - Where contagion is a concern, large-scale financing without debt relief postpones resolution; alternative responses include addressing contagion directly (e.g., proactive recapitalization of creditor banks, establishment of firewalls, provision of liquidity). - The exception to the “high probability” standard in the exceptional access policy (for systemic spillovers) could usefully be reviewed. --- ### Collective action problems, CACs, aggregation clauses, and litigation risks - Collective action problems impede restructuring because creditors may pursue holdout strategies; holdouts have typically been paid in full after preemptive restructurings in some cases. - SDRM vs CACs (selected numeric thresholds and features): - CACs: a qualified majority of bondholders (typically 75 percent of the outstanding principal) can bind all bondholders within the same issue. - SDRM: required support of 75 percent of the outstanding principal of verified claims on an aggregated basis to bind all affected creditors. - Under CACs, normally 25 percent of the outstanding principal of a series is required to accelerate claims of that series after default. - Under the SDRM, approval of 75 percent of aggregated outstanding principal could effect a temporary suspension of legal actions for all creditors. - Key SDRM features included activation by a Fund member who must represent that debt is unsustainable, creditor committees, specified priority financing approved by 75 percent, and an independent dispute-resolution forum. - Contractual aggregation clauses: - Aggregation clauses have been included in bonds of Argentina, the Dominican Republic, Greece, and Uruguay. - Typical aggregated framework: two voting thresholds if sovereign elects aggregated amendments: - 75 percent (Greece) or 85 percent (Argentina, Uruguay, Dominican Republic) of aggregated outstanding principal of all series to be affected; - 66⅔ percent of the outstanding principal of each individual series to be affected. - Limitations: 66⅔ percent per-series threshold still permits blocking positions; aggregation applies only to bond series under the same trust indenture or trust deed. - Greek legislative aggregation: - EUR 184 billion of Greek debt was governed by Greek law and did not have CACs; domestic legislation (Law No. 40/50/2012 enacted on February 23, 2012) enabled aggregated voting with a two-thirds voting threshold of aggregated outstanding principal based on a quorum of 50 percent. - Of 36 bonds governed by English law with CACs, only 17 were successfully restructured; unrestructured claims amounted to about EUR 6.5 billion, accounting for 30 percent of total value of debt governed by foreign law. ### Argentine pari passu litigation and potential effects - Second Circuit Court of Appeals in New York upheld District Court’s interpretation of pari passu to require ratable payments to restructured bondholders and holdouts; District Court’s order (if upheld) could prohibit Argentina from paying restructured bonds unless it pays holdouts in full. - Timeline items preserved from source: - March 1: Second Circuit ordered Argentina to propose a plan for making “current those obligations on the defaulted bonds that have gone unpaid over the last 11 years.” - March 29: Argentina submitted a letter proposing to apply the 2005 and 2010 restructuring terms to the defaulted bonds and to bring current the interest payments on the original bonds in the same manner provided for in connection with those restructurings. - April 19: the holdouts rejected the Argentine proposal. - The Second Circuit Court has rejected Argentina’s petition for a rehearing by the same panel or en banc. - Potential consequences if decisions are upheld: - Holdouts gain greater legal leverage and ability to interrupt payments to restructured creditors. - Two principal adverse effects: - Discouragement of creditor participation in voluntary restructurings because holdouts could interrupt flows to participating creditors. - Increased risk of multiplying holdouts and refraining creditors due to inter-creditor equity concerns. - Jurisdictional note: no evidence at this stage that English courts will follow the New York approach. - Market responses: - Belize (February 2013 exchange and legislation) explicitly stated its pari passu clause does not require ratable payments to prevent Argentina-style litigation. - Italy modified its Fiscal Agency Agreement to remove reference to equal and ratable payments and to clarify pari passu requires equal ranking of unsecured and unsubordinated obligations. - Related litigation example: March 4 action by Export-Import Bank, Taiwan POC against Grenada in New York seeking specific performance of pari passu. ### Credit default swaps (CDS) — limited evidence and Greek observations - CDS impact not fully tested; ISDA auction used only for Ecuador and Greece to determine recovery rates. - Greece observations: - ISDA auction occurred 10 days after the debt exchange; old GGBs had been exchanged and were not deliverable. - CDS payouts were 78.5 cent per dollar and closely aligned with losses in the debt exchange (noted as possibly coincidental). - Legal uncertainty existed about whether certain official measures in the Greek restructuring triggered CDS credit events. - Market effects included decline in price of new GGBs and reluctance of institutions to sell CDS on new bonds during the 60-day “look-back period”. ### Potential Fund policy responses to collective action problems - Options identified for further study: - Condition availability of Fund financing more tightly to resolution of collective action problems. - Require high minimum participation thresholds in debt exchanges launched under Fund-supported programs. - Routinely issue statements alerting creditors that securing critical participation mass is required for restoration of external stability; failure could block future program financing. - In pre-default restructurings, set clearer expectations that non-negotiated offers following informal consultations may be the norm to preserve speed and avoid default. --- ### Official Sector Involvement (OSI) and financing assurances - Heavy reliance on official lending may inhibit spontaneous market access because private creditors may fear subordination to official creditors. - Exceptional access criterion: market reaccess test complicated when official lenders make open-ended commitments to support until market access is regained (example: Greece). - Suggestion: condition commitments from official lenders to cooperation with the Fund in the context of a program rather than ex ante program targets that may evolve. - Financing assurances from non-Paris Club creditors lack a specific standard; Fund policy relies on Paris Club conventions and comparability of treatment principle, which may be inadequate as the composition of official creditors changes. - Historical examples of financing assurances: - Poland (1990): Paris Club press release required in advance of SBA review specifying amount and timing of debt reduction. - Egypt (1991): Paris Club press release prior to Fund disbursement; staff report required written assurances. - Iraq (2004): Managing Director convened Executive Directors representing Iraq’s major creditors to obtain confirmation of assurances. - Seychelles (2008): South Africa participated in Paris Club negotiations and was a signatory of the Agreed Minutes; Fund required Agreed Minute and staff acknowledgement of unsustainable debt and creditor debt reduction timing/amounts. - Greece (2012): EFF approval relied on European partners’ commitment to “provide adequate support to Greece during the period of the Greek policy program and beyond for as long as it takes to regain market access.” --- ### Asymmetry in treatment of arrears and review of LIA - Asymmetry: private external arrears tolerated under LIA; arrears to official bilateral lenders are not tolerated. - Risks: Fund could be unable to assist a member due to holdout official bilateral creditors seeking favorable treatment. - Considerations: - Extend LIA policy to official bilateral arrears and clarify modalities through which non-Paris Club official lenders provide assurances of debt relief. - Paris Club expansion to include all major lenders could allow reliance on Paris Club conventions, but feasibility is uncertain. - LIA policy review warranted given experience (notably Argentina) and changes in creditor base. - Application uneven: - In four Fund-supported programs reviewed (Dominican Republic, Grenada, Seychelles, St. Kitts and Nevis), LIA policy was considered met. - Coverage of debtor–creditor relations in staff reports varied and assessments of the good faith criterion were sometimes cursory. - Argentina-specific observations: - 2003 Fund-supported programs lacked a fully quantified medium-term fiscal framework; negotiation over fiscal framework reduced Fund’s role in setting resources envelope for restructuring. - Over thirty creditors’ committees existed; GCAB represented about one-half of Argentina’s external private debt and was deemed representative for LIA purposes, but no constructive dialogue occurred and a non-negotiated offer led to restructuring of eligible debt and past due interest of about two-fifths of total debt, more than three years after default. ### Changes in creditor landscape complicating representation - Creditors have increased in number and dispersion, adopted different accounting rules, and display different holding patterns and incentives, complicating the ability for any creditor committee to be fully representative. --- ### Proposals and differences with Fund policy (IIF addendum, ECRM, SDRM, IDRC, SDF, others) - Notable proposals described in source: - European Crisis Resolution Mechanism (ECRM): EU-wide statutory regime with features including stay of litigation and aggregated voting. - Amendment of ESM treaty: proposal to immunize debtor country assets from attachment by holdouts. - Sovereign Debt Tribunal (SDT) / Fair and Transparent Arbitration Process (FTAP): tribunal or arbitration processes. - International Debt Restructuring Court (IDRC): UN experts’ proposal for a court with powers on principles, odious debt, and debtor-in-possession financing. - Sovereign Debt Forum (SDF): non-statutory neutral standing body for early consultation. - Automatic maturity extension proposal for Euro Area bonds tied to ESM assistance. - IIF Addendum (October 2012): supplements 2006 IIF Principles; contains elements contributing to financial stability but includes positions not fully consistent with Fund policies. - Key differences between IIF Principles / Addendum and Fund policy (selected): - Involvement in DSA: Addendum encourages greater private creditor involvement in setting DSA parameters; Fund preserves independence of staff in determining macro framework and DSA. - Role of creditor committees: Addendum proposes early broad-based committees; LIA requires committees only in complex cases where representative committees form timely. - Inter-creditor equity: Addendum favors comparable treatment of all creditors; Fund accepts differentiated treatment where necessary to limit economic dislocation, maintain market access, and preserve financial stability. - Other divergences: timing of negotiations, voluntary standstills on litigation, resumption of partial debt service as good-faith signal, and call for simultaneous official restructuring when sovereign restructures with private creditors. - Given differences, the Fund cannot endorse the IIF Principles and Addendum as currently constituted. ### Monitoring and proposed staff follow-up - Four areas for possible staff follow-up papers if Directors support: - Better understand causes of delayed and inadequate restructurings and options to make restructurings more timely and effective. - Consider options to make contractual, market-based approaches more effective at overcoming collective action problems, especially pre-default. - Clarify framework for official sector involvement given changing composition of official lending. - Review effectiveness of the LIA policy given recent experience and creditor base complexity, while recognizing collaborative, good-faith approach remains the most promising route post-default. --- ### Annex I — financing assurances and external arrears (policy highlights) - Financing assurances policy objective: ensure Fund financing consistency with member’s return to viability so Fund can be repaid within the medium term. - Practical financing adequacy judgments at approval: - "Firm commitments" must be in place for the first 12 months of the arrangement. - There must be "good prospects" that adequate financing will be available for the remaining program period beyond the first 12 months. - During program reviews, assurances on full financing of successive 12-month periods beyond the initial 12 months must be ascertained; "good prospects" should become "firm commitments" or actual financing. - Arrears policy: - General non-toleration of external payments arrears; Article V, Section 3 provides legal basis. - LIA (1989) is a limited exception allowing approval of an arrangement before arrears to external private creditors are eliminated where (i) prompt Fund support is essential and (ii) member pursues appropriate policies and makes a good faith effort to reach a collaborative agreement with private creditors. - Each disbursement under an arrangement subject to financing assurances review; Board considers whether adequate safeguards remain and whether adjustment efforts are being undermined by debt–creditor relations. - Good faith criterion (introduced 1998) aims to promote collaborative, timely restructurings and assess procedural expectations (early dialogue, information sharing, creditor input, representative committees in complex cases), while preserving flexibility to tailor modalities and avoiding creditor vetoes over program design. *Source: _042613* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Recent developments in sovereign debt restructuring - Greece launched the largest sovereign debt restructuring in history in February 2012 covering EUR 205 billion in debt. - Other recent restructurings and related actions include Belize (2007, 2013), Jamaica (2010, 2013), St. Kitts and Nevis (2012), and Grenada (announced intention to restructure public debt). - Ongoing litigation against Argentina could have pervasive implications for future sovereign debt restructurings by increasing leverage of holdout creditors. - The Institute for International Finance (IIF) issued an annex to its Principles in light of the restructuring experience in Greece. - Active discussion of debt restructuring issues has taken place in international fora. ### Scope and purpose of the paper - Recaps in a holistic manner the policies and practices forming the Fund's legal and policy framework for sovereign debt restructuring, including: - debt sustainability, - market access, - financing assurances, - arrears, - private sector involvement (PSI), - official sector involvement (OSI), - use of legal instruments. - Reviews how this framework has been applied in Fund-supported programs and highlights issues emerging from recent restructuring experience. - Describes recent initiatives in various fora aimed at promoting orderly sovereign debt restructuring and highlights differences with the Fund’s existing framework. - Identifies issues for further staff follow-up to assess whether the Fund’s framework for debt restructuring should be adapted. ### Key findings and issues identified for further work - First: Restructurings have often been "too little and too late", failing to re-establish debt sustainability and market access durably. - Possible responses include: - (i) increased rigor and transparency of debt sustainability and market access assessments; - (ii) exploring ways to prevent the use of Fund resources to simply bail out private creditors; - (iii) measures to alleviate the costs associated with restructurings. - Second: The current contractual, market-based approach to debt restructuring is becoming less potent in overcoming collective action problems, especially in pre-default cases. - Considerations include: - introducing more robust aggregation clauses into international sovereign bonds, while bearing in mind inter-creditor equity issues; and - conditioning use of Fund financing more tightly to the resolution of collective action problems. - Third: The growing role and changing composition of official lending call for a clearer framework for official sector involvement, especially regarding non-Paris Club creditors. - The modality for securing program financing commitments from such creditors could be tightened. - Fourth: The collaborative, good-faith approach to resolving external private arrears embedded in the lending into arrears (LIA) policy remains the most promising way to regain market access post-default. - A review of the effectiveness of the LIA policy is warranted in light of recent experience and the increased complexity of the creditor base. - Consideration could be given to extending the LIA policy to official arrears. ### The Fund’s approach and operational considerations - The Fund’s lending mandate is to provide financing to assist members in resolving balance of payments problems within a timeframe that allows them to return to medium-term viability and repay the Fund. - In many programs, Fund financing catalyzes spontaneous external private financing and sometimes official financing, enabling members to continue servicing debt and preserve market access. - When members with significant external indebtedness have lost or are losing market access: - financing needs may exceed the Fund’s financing capacity and the member’s adjustment capacity; - the Fund requires adequate financing assurances from other sources to fill residual gaps during and after the program; - the Fund’s policy on financing assurances explicitly encourages “the restructuring of creditors’ claims on the country on terms compatible with balance of payments viability” when gaps cannot be filled. - Distinction between illiquidity and solvency problems: - Illiquidity cases typically require rescheduling of maturing obligations if good prospects for market access restoration exist. - Solvency cases may require reduction in the debt stock. - The Fund is precluded from providing financing unless steps are taken to restore sustainability, which can include restructuring of private and/or official sector claims. - Rapid restructuring is beneficial: - Delays can exacerbate indebtedness, increase economic dislocation, prolong financial instability and subdued growth, and worsen moral hazard and burden-sharing problems. ### Paper conclusions and recommended next steps - Recent developments warrant revisiting certain aspects of the Fund’s sovereign debt restructuring framework. - Four areas merit further in-depth staff analysis: - (i) addressing restructurings that have been too little and too late; - (ii) strengthening tools to overcome collective action problems within the contractual, market-based approach; - (iii) clarifying the framework for official sector involvement in light of the changing composition of official lending; and - (iv) reviewing the effectiveness of the LIA policy and considering its extension to official arrears. *Source: EXECUTIVE SUMMARY — April 26, 2013* ### 10. Debt sustainability is a key requirement for Fund lending. It is a prerequisite for external ### 10. Debt sustainability is a key requirement for Fund lending. It is a prerequisite for external ### Debt sustainability and exceptional access - Debt sustainability is a prerequisite for external viability, program success, and Fund safeguards. - The exceptional access policy (when the Fund lends above the normal access limits) makes the debt sustainability criterion particularly relevant. - Until May 2010, the exceptional access policy required that “a rigorous and systematic analysis indicates that there is a high probability that the member’s debt is sustainable in the medium term.” - This “high probability” standard reflected a form of “constrained discretion” to balance judgmental assessments and the risk of undue pressure to continue large financing without restructuring. - In May 2010, in the context of the European crisis, the criterion was amended to create an exception to the “high probability” requirement where “there is a high risk of international systemic spillovers.”6 ### Market access and its relationship to sustainability - Market access is closely related to debt sustainability and a separate criterion under the exceptional access policy. - The policy requires that the member has prospects of (re)gaining access to private capital markets within the timeframe when Fund resources are outstanding. - Practical assessment of market access depends on the country’s ability to tap international capital on a sustained basis through contracting loans and/or issuing securities: - across a range of maturities, - regardless of currency denomination, - and at reasonable interest rates. - The pace of market reaccess must enable the country to repay the Fund, taking into account the maturity structure of Fund financing. - A temporary loss of market access does not necessarily imply unsustainability; a protracted loss creates a presumption that debt may not be sustainable. ### Debt Sustainability Analysis (DSA) framework - The Fund has developed a framework for rigorous debt sustainability analysis (DSA) to inform lending and restructuring decisions and crisis prevention. - A DSA provides: - a thorough examination of debt structure, - projections for debt burden indicators in baseline, alternative, and stress test scenarios, - coverage over the medium term (generally understood to cover a period of five years). - Debt sustainability judgments require that: - the primary balance needed to stabilize debt under both the baseline and realistic shock scenarios is credible (economically and politically feasible), - the level of debt is consistent with an acceptably low rollover risk and with preserving potential growth at a satisfactory level.7 - In Fund-supported programs involving debt restructuring, the DSA determines the envelope of financial resources available for debt service to official and private creditors by charting medium-term paths for key macroeconomic, policy, and financing variables. ### Requirements when envisaging debt restructuring - If the Fund determines debt is unsustainable and the member initiates restructuring, the Fund must judge that the envisaged restructuring: - (i) makes the debt sustainable, and - (ii) is likely to be successful in attracting sufficient creditor participation and avoiding disruptive legal challenges. ### Debt restructuring process: preemptive restructurings - The Fund encourages collaborative engagement between the member and creditors and recommends avoiding default by remaining current on obligations where possible. - A member should seek a “preemptive” restructuring and continue servicing original claims during the restructuring process. - The Fund does not require a particular form of dialogue in preemptive cases; a non-negotiated offer following informal consultations may be efficient. - Inter-creditor equity is more acute in pre-default restructurings due to differences in market value of debt by maturity; resolution requires debtor-creditor dialogue on equitable treatment. ### Lending into Arrears (LIA) and post-default restructurings - The Fund can support members seeking to restore sustainability via post-default restructuring and has adapted lending policies to balance orderly financial relations and limit economic dislocations. - The Lending into Arrears (LIA) policy applies to: - (i) sovereign arrears to external private creditors, and - (ii) nonsovereign arrears to external private creditors from exchange controls. - Under LIA, the Fund may lend to a member in sovereign arrears to external private creditors only where: - (i) prompt Fund support is considered essential for successful implementation of the member’s adjustment program, and - (ii) the member is pursuing appropriate policies and is making a “good faith effort” to reach a collaborative agreement with its private creditors (the policy sets expectations on the form of the dialogue).8 - Where an organized negotiating framework is justified and creditors have formed a representative creditors committee, the sovereign would be expected to enter into good faith negotiations with that committee (a higher bar than pre-default interaction expectations). - The policy also establishes that private creditors should not have a veto over the design of the financing plan or the adjustment program. ### Arrears to official creditors - The Fund does not tolerate “unresolved” arrears to official bilateral or multilateral creditors and has conventions for application: - Arrears to multilateral creditors are considered resolved if the program provides for their clearance.9 - Arrears to Paris Club official bilateral creditors covered by the anticipated terms of the Club’s “Agreed Minute” are deemed resolved for Fund program purposes when financing assurances are received from the Paris Club prior to approval or completion of review.10 - Relying on the Paris Club’s comparability of treatment principle, the Fund deems non-Paris Club official bilateral creditors will restructure on similar terms as Paris Club creditors; tacit approval (e.g., non-objection in the Executive Board) can be sufficient where no formal Agreed Minute exists.11 ### Collective action problems, CACs, and the SDRM - Collective action problems can impede restructuring because creditors may fear holdout strategies or delay. - Holdouts have typically been paid in full after a preemptive restructuring. - The Sovereign Debt Restructuring Mechanism (SDRM) received considerable Board support but failed to secure the majority needed to amend the Fund’s Articles of Agreement; members were reluctant to surrender required sovereignty. - The Fund supported a contractual-based approach: inclusion of collective action clauses (CACs) in international sovereign debt contracts via multilateral and bilateral surveillance.12,13 Box 1 — Key features (selected, as provided) - CACs and the SDRM both address collective action problems by enabling qualified majority voting by creditors. - Differences and specific numeric thresholds: - Restructuring agreement: - CACs: a qualified majority of bondholders (typically 75 percent of the outstanding principal) can bind all bondholders within the same issue. - SDRM: required support of 75 percent of the outstanding principal of verified claims on an aggregated basis to bind all affected creditors. - Limitation of creditor enforcement: - Under CACs, normally 25 percent of the outstanding principal of a particular series is required to accelerate claims of such series after a default; a simple or qualified majority can reverse such acceleration after default is cured. - Under the SDRM, upon request of the activating member and approval of 75 percent of aggregated outstanding principal of verified claims, a temporary suspension of legal actions would become effective for all creditors. - Key SDRM features (selection): - Activation only at request of a Fund member who must represent that the debt is unsustainable; could apply to all external claims. - Creditor committees: representative creditors’ committee, if formed, would have a role; debtor bears committee costs. - Priority financing: specified financing could be excluded from restructuring if approved by 75 percent of outstanding principal of verified claims. - Termination: automatic upon certification of all restructuring agreements, by notice of the activating member, or upon completion of registration/verification if 40 percent of verified claims wish to terminate. - Independent dispute resolution forum to verify claims, adopt voting rules, certify agreements, suspend legal proceedings, and adjudicate disputes. *Source: IMF chapter on Sovereign Debt Restructuring (section 10–Box 1 excerpts).* ### 20. This section provides a preliminary review of Fund policies discussed in Section II in ### _042613 - 20. This section provides a preliminary review of Fund policies discussed in Section II in ### Overview and issues identified - The section provides a preliminary review of Fund policies discussed in Section II in light of recent experience in sovereign debt restructuring. - It identifies four issues for further study: - debt restructurings have often been too little and too late, thus failing to re-establish debt sustainability and market access in a durable way; - while creditor participation has been adequate in recent restructurings, the current contractual, market-based approach to debt restructuring is becoming less potent in overcoming collective action problems, especially in pre-default cases; - the growing role and changing composition of official lending call for a clearer framework for official sector involvement; and - although the collaborative, good-faith approach to resolving external private arrears embedded in the LIA policy remains the most promising way to regain market access post-default, a review of the effectiveness of the LIA policy, including the requirement for the sovereign debtor to negotiate with representative creditor committees, is in order in light of recent experience and given the increased complexity of the creditor base. ### A. Restructurings That Are Too Little and Too Late — key findings - Recent experience suggests unsustainable debt situations often fester before being resolved; when restructurings do occur they do not always restore sustainability and market access durably, leading to repeated restructurings. - Pressures to delay restructurings arise from: - authorities’ concerns about financial stability and contagion; - parallel incentives of official creditors who may accept sanguine assessments of debt sustainability and market reaccess. - Empirical examples where staff assessed unsustainable debt well before restructurings: - Belize: staff noted concerns in the 2005 Article IV consultation; restructuring occurred in 2007 (outside a Fund-supported program). - Seychelles: staff noted debt unsustainable as early as the 2003 Article IV report; default in 2008 and restructuring in 2009–10 after seeking Fund assistance. - St. Kitts and Nevis: DSAs in Article IV staff reports from as far back as 2006 showed an explosive debt path; government announced intention to restructure only in 2011 in the context of a new Fund-supported program. - Loss of market access was often a proximate trigger for approaching the Fund and for restructuring (Figure 1 timeline evidence for multiple countries). ### Timing, contagion, and policy constraints - Greece illustrates difficulty of early restructuring even under sustained loss of market access due to availability of official financing and stated willingness to undertake unprecedented fiscal adjustment. - Exceptional access policy required demonstration of a “high probability” of debt sustainability; policy was amended to create an exception where “there is a high risk of international systemic spillovers”. - Private debt restructuring for Greece was launched in February 2012 after planned adjustment proved unfeasible. - Some countries avoided outright restructuring historically by combining official financing and adjustment (example: Turkey in the early 2000s used depreciation, fiscal tightening, bank restructuring, voluntary rollover agreements, and bank shareholder bail-ins; preserved market access at very high interest rates). - Allowing unsustainable debt to persist imposes costs: - For debtors: depressed investment and growth, financial uncertainty increasing eventual magnitude of debt problems. - For creditors: delays reduce economic value of claims and concentrate losses on remaining creditors when restructuring occurs. - For the Fund: continued financing during delays creates additional financial risks and makes resolving balance of payments problems harder. - Pressures to delay are common and arise from: - debtor governments’ fear of economic, financial and political fallout (e.g., Jamaica’s 2010 restructuring addressed a debt level of 124 percent of GDP with a flow rescheduling and no principal haircut for financial stability reasons); - official creditors’ concerns about reduced adjustment incentives, recognition of losses by banks in their jurisdictions, market turmoil, or desire to preserve future flexibility; - private creditors’ preference for official bailouts to avoid restructuring. ### Characteristics and outcomes of recent restructurings - Face-value haircuts were substantive only in Argentina, Ecuador, Greece, Seychelles, and St. Kitts and Nevis (ranging from 30 to 70 percent). - Some restructurings relied on NPV reductions via maturity extensions and below-market rates; achieved debt relief is sensitive to discount rate choice. - Table 1 (case details) examples (selected exact figures preserved from source): - Argentina (Dom./Ext. Bonds): Post-Default, Default Date Jan-02; Total Duration (Months) 21; Debt Exchanged in US$ bn 81.80; Cut in Face Value 43.4%. - Greece (Dom./Ext. Bonds): Preemptive, Preemptive Default Date Jul-11; Total Duration (Months) 8; Debt Exchanged in US$ bn 271.22; Cut in Face Value 53.5%. - Seychelles (Ext. Bonds/Loans): Post-Default, Default Date Jul-08; Total Duration (Months) 11; Debt Exchanged in US$ bn 0.32; Cut in Face Value 50.0%. - St. Kitts and Nevis (Bonds/Loans): Preemptive, Default Date Jun-11; Total Duration (Months) 10; Debt Exchanged in US$ bn 0.14; Cut in Face Value 31.8%. - Jamaica (Dom. Bonds) 2010 restructuring: attempted to address debt level of 124 percent of GDP with flow rescheduling and no principal haircut. - Despite restructurings, many countries returned to reliance on official financing and multiple restructurings were common: - Five of nine studied cases (Argentina, Belize, Greece, Grenada, Jamaica) experienced two or more restructurings of private and/or official claims. - Only a few cases restored debt sustainability convincingly: - Seychelles: 45 percent haircut (nominal) on official debt and 50 percent haircut on private bondholders with 100 percent participation reduced public debt from about 130 percent of GDP at end-2008 to 78 percent at end-2012; immediate upgrade in creditworthiness improved market access prospects. - St. Kitts and Nevis: bond exchange with a haircut of 50 percent in NPV terms and a debt-land swap helped reduce public debt from about 154 percent of GDP at end-2011 to 92 percent at end-2012. - Time to regain market access depends on country-specific and global factors (Dominican Republic regained market access relatively quickly partly due to favorable external conditions). ### Policy implications and areas for follow-up staff work - Assess whether and how the Fund’s sovereign debt restructuring framework should be adapted in light of: - the tendency for restructurings to be delayed and inadequate to restore sustainability; - weakening potency of contractual, market-based approaches to overcome collective action problems in complex creditor bases and pre-default contexts; - the growing role and changing composition of official lending and the need for clearer official sector involvement frameworks; - the need to review the effectiveness of the LIA policy and the requirement for sovereign debtors to negotiate with representative creditor committees given increased creditor complexity. - Consideration of contagion concerns: - Contagion can be legitimate in some circumstances, but contagion risk should not override the primary duty to help members resolve balance of payments problems. - Where contagion is a concern, Fund responses that provide large-scale financing without debt relief will only postpone resolution; instead, address contagion effects directly (e.g., require currency union authorities to establish safeguards such as proactive recapitalization of creditor banks, establishment of firewalls, provision of liquidity support). - The modification of the exceptional access policy (second criterion) that created an exception to the requirement for achieving debt sustainability with a high probability in the presence of systemic international spillovers could usefully be reviewed. - Suggested topics for further study: - deeper analysis of cases where countries avoided outright restructuring through adjustment and official financing (e.g., Turkey) versus cases where delays increased ultimate resolution costs; - evaluation of the pros and cons of using PV calculations for estimating debt reductions for market access countries undergoing debt restructuring; - review of the effectiveness of the LIA policy in light of recent experience and increased creditor complexity. *Source: _042613 - 20.* ### 29. In hindsight, the Fund’s assessments of debt sustainability and market access may ### _042613 - 29. In hindsight, the Fund’s assessments of debt sustainability and market access may ### Hindsight on debt sustainability and market access assessments - The existing DSA framework does not specify the period over which debt sustainability or market access is supposed to be achieved (generally understood as within a five-year horizon). - Maximum sustainable debt ranges and the horizon for achieving sustainability have largely been left to Fund staff judgment. - Sustainability was generally assessed on the basis of an eventual decline in the debt-to-GDP ratio. - Only Argentina, Seychelles and St. Kitts and Nevis were cases that provided for a quick and sizable reduction in debt-to-GDP levels post-restructuring. - St. Kitts and Nevis targeted an explicit debt threshold: the ECCU debt target of 60 percent of GDP by 2020. - Most other cases allowed more than five years for debt to fall significantly below safe levels: - Greece: debt-to-GDP ratio in the most recent program projections is not expected to be reduced substantially below 110 percent before 2022. - Jamaica (forthcoming Fund-supported program at the time): debt projected to remain close to 120 percent of GDP in five years’ time. - In Grenada the debt ratio at the end of the five-year horizon turned out much higher than staff projections at the time of the restructuring. - Staff medium-term debt projections were revised upward substantially within only a few years after restructurings in Greece, Jamaica (2010) and Seychelles. ### Need for a multipronged approach to ensure timely restructurings - Overcoming delays and inadequacy of restructurings likely requires action on several fronts, including a combination of: - Increased rigor and transparency of debt sustainability and market access assessments. - Stricter requirements to prevent the use of Fund resources to bail out private creditors. - Measures to alleviate the costs associated with restructurings. ### Increasing rigor and tightening lending policy requirements - The recently issued guidance note to staff on preparing DSAs for market-access countries mandates: - More systematic assessments and transparent reporting of risks to the baseline. - Drawing on alternative stress-test scenarios. - Greater attention to debt levels and risks to funding sources and market access. - Systematic assessments of the (economic and political) realism of fiscal adjustments and other assumptions underpinning the DSA. - Even with improvements, DSAs remain judgmental exercises, leaving discretion to the Fund on when to declare debt unsustainable; greater standardization and transparency will help limit discretion. - Consideration could be given to removing the exception to the original requirement of “high probability” of debt sustainability under the exceptional access policy when there are risks of systemic spillovers. - Further work on analytical tools to assess prospects for market access could support stricter evidentiary requirements in the exceptional access policy. ### Limiting the risk that Fund resources bail out private creditors - Proposal: establish a presumption that some form of creditor bail-in measure would be implemented as a condition for Fund lending in cases where: - No clear-cut determination has been made that debt is unsustainable, but the member has lost market access and prospects for regaining market access are uncertain. - Purpose of creditor bail-in in such cases: - Ensure creditors do not exit while the Fund is providing financial assistance. - Give time to determine whether the problem is liquidity or solvency. - Typically involve rescheduling of debt rather than debt stock reduction. - Provide a more comfortable debt profile to enhance market confidence and reduce risk of debt becoming unsustainable. - Bail-in measures would be voluntary (ranging from rescheduling of loans to bond exchanges resulting in long maturities); success of such measures would be a condition for continued Fund support. - Debt rescheduling instead of debt reduction is not appropriate when the problem is clearly one of solvency; in that case, upfront debt reduction is preferred. ### Alleviating costs associated with restructurings - Sovereign attempts to proactively involve private creditors can carry undesirable consequences: delayed market reaccess, impaired financial intermediation, contagion. - The Fund’s approach could be better tailored to cushion these effects to encourage earlier restructurings when needed. - Staff could explore: - Making available Fund financing on supportive terms (e.g., longer maturities) while minimizing moral hazard. - Ways to cushion costs of the debt restructuring process to encourage earlier initiation. - Ways to mitigate financial stability and contagion concerns (e.g., seeking assistance of other institutions and country authorities—especially in currency unions—to enable proactive recapitalization of creditor banks and central bank provision of liquidity). ### Collective action problems and contractual vs. statutory approaches - Recent restructurings were mostly preemptive; all except Argentina, Ecuador, and Seychelles were preemptive. - Several restructurings achieved creditor participation rates above 90 percent (Belize (2007), Grenada, Jamaica, and St. Kitts and Nevis), though Belize, Grenada, and Jamaica restructurings did not effectively restore debt sustainability. - Argentina (post-default) had a higher proportion of holdouts: 24 percent; it also involved a larger NPV haircut. - Greece achieved very high creditor participation: 97 percent, despite being preemptive and targeting a very large haircut (70 percent in NPV terms relative to par). - The Fund played an important role encouraging creditor participation (e.g., assessment letters, press releases, staff participation in road shows). ### Inter-creditor equity, differentiated treatment, and litigation - Differential treatment of creditors has been common to reflect creditor preferences, financial stability, market access, and trade credit considerations. - Seychelles offered different terms to domestic and foreign residents to protect the domestic banking sector. - Belize (2007, 2013) did not include any domestic instruments in the restructuring. - Jamaica (2010, 2013) affected the entire stock of domestic public debt while leaving Eurobonds in international markets out to preserve market access. - Creditor litigation has been rare except for Argentina (2005) with more than 50 litigation cases filed in the U.S. and the U.K., and litigation related to Greece. ### Role and limits of CACs and other market instruments - CACs were useful in recent restructurings (Belize, Seychelles, St. Kitts and Nevis) enabling full creditor participation, but they have limits. - Other market-based instruments used to secure participation included: - Minimum participation thresholds (ranging from 75 percent to 90 percent). - Exit consents (used in Belize and Dominican Republic). - Menus of instruments appealing to investor preferences, credit enhancements (upfront cash repayments, cash-equivalent notes, add-ons such as GDP-linked warrants), and regulatory sweeteners. - Example metric: minimum participation thresholds ranged from 75 percent to 90 percent. ### Greek experience: CACs versus statutory aggregation - Of Greece’s total debt value EUR 205 billion, 7.3 percent was governed by foreign law and included CACs. - CACs bind holders on an issue-by-issue basis; creditors could obtain a blocking majority in specific series preventing operation of CACs. - In Greece: - Of the 36 bonds governed by English law with CACs eligible to participate, only 17 were successfully restructured using CACs. - Unrestructured claims amounted to about EUR 6.5 billion, accounting for 30 percent of the total value of debt governed by foreign law. - EUR 184 billion of Greek debt was governed by Greek law and did not have CACs; domestic legislation (Law No. 40/50/2012 enacted on February 23, 2012) enabled a qualified majority of bondholders to bind all holders of affected domestic debt to restructured terms. - The legislative approach aggregated claims across affected domestic-law issuances and used a low voting threshold: two-thirds of aggregated outstanding principal of all affected domestic law bonds based on a quorum of 50 percent. - The aggregation feature in Greek legislation functionally resembles aspects of the SDRM but differs in scope and legal basis: - SDRM would be a universal treaty, apply to all debt instruments, and be subject to an international forum; Greek legislation applied domestically and to domestic-law bonds. - At the time, there did not appear to be sufficient support within the membership to amend the Articles of Agreement to establish a universal treaty. ### Contractual aggregation clauses and their limits - Aggregation clauses have been included in sovereign bonds of Argentina, the Dominican Republic, Greece, and Uruguay. - Typical contractual aggregation framework: - Two voting thresholds if sovereign elects aggregated amendments: - 75 percent (Greece) or 85 percent (Argentina, Uruguay, Dominican Republic) of the aggregated outstanding principal of all series to be affected. - 66⅔ percent of the outstanding principal of each individual series to be affected. - The 66⅔ percent threshold is lower than the typical 75 percent majority needed under standard CACs (which apply on a series-by-series basis). - Limitations of contractual aggregation: - The 66⅔ percent per-series threshold still enables a creditor to obtain a blocking position in a particular issuance. - Aggregation applies only to bond series issued under the same trust indenture or trust deed. - These limitations can be significant in practice; e.g., in Greece it is doubtful that a two-tier voting framework would have secured participation for large near-term series. *Source: IMF staff reports contained in the cited chapter.* ### 42. There is merit in considering whether a more robust form of aggregation clause could ### _042613 - 42. There is merit in considering whether a more robust form of aggregation clause could ### Aggregation clauses and collective action clauses (CACs) - Consideration: design and introduce a more robust form of aggregation clause into international sovereign bonds. - Possible reforms: - Make aggregated voting in collective action clauses standard practice in new bond issuances. - Replace the standard two-tier voting thresholds in existing aggregation clauses with one voting threshold so that blocking minorities in single bond series cannot derail an otherwise successful restructuring. - Remove the individual issuance voting tier to reduce the leverage of holdouts. - Trade-offs and risks: - Removing the individual issuance voting tier may give rise to inter-creditor equity concerns where claims being aggregated have different maturities associated with different economic interests. - This inter-creditor equity concern will be more acute in pre-default cases. - Limitation: These provisions would help in the long run, even though legacy debt will not be affected. ### Argentine litigation, pari passu interpretation, and implications for restructurings - Recent litigation developments: - The Second Circuit Court of Appeals in New York upheld the District Court’s interpretation of the pari passu clause in defaulted bonds to require ratable payments to restructured bondholders and holdout creditors. - The District Court’s order, if upheld, would prohibit Argentina from making payments on its restructured bonds unless it pays in full the principal and interest owed and past due on the original unrestructured claims. - The District Court’s order would also prohibit the trustee and other parties involved in the payment chain from distributing any payments to holders of restructured bonds unless holdout creditors are simultaneously paid in full. - The District Court’s order has been suspended by the Second Circuit Court pending its assessment of the formula Argentina will be required to use to pay the holdouts as well as coverage of the third parties subject to the court order. - Timeline items preserved from the text: - On March 1, the Second Circuit Court ordered Argentina to propose a plan for making “current those obligations on the defaulted bonds that have gone unpaid over the last 11 years.” - On March 29, Argentina submitted a letter proposing to apply the 2005 and 2010 restructuring terms to the defaulted bonds and to bring current the interest payments on the original bonds in the same manner provided for in connection with those restructurings. - On April 19, the holdouts responded by rejecting the Argentine proposal. - The Second Circuit Court has rejected Argentina’s petition for a rehearing by the same panel or en banc. ### How Argentine decisions could affect collective action and restructuring dynamics - Potential consequences if decisions are upheld: - Holdout creditors would gain greater legal leverage and ability to interrupt payments to restructured creditors. - Two principal adverse effects on restructuring: - Discouragement of creditor participation in voluntary restructurings because holdouts could interrupt flows to participating creditors. - Increased risk that holdouts will multiply and that creditors otherwise inclined to agree to restructuring may refrain due to inter-creditor equity concerns. - Jurisdictional note: - No evidence at this stage that English courts will follow the New York approach. - Observed market response: - Belize, in its February 2013 debt exchange offer and related legislation, explicitly stated that the pari passu clause in the restructured bonds does not require Belize to pay all items of its public debt on a ratable basis to prevent the holdout strategy used against Argentina and to mitigate litigation risks. - Italy modified its Fiscal Agency Agreement to remove reference to equal and ratable payments and to clarify that the pari passu clause requires equal ranking of all unsecured and unsubordinated obligations. - Related litigation example: - On March 4, the Export-Import Bank, Taiwan POC commenced an action in New York seeking specific performance of the pari passu provision against Grenada and an order preventing payment on outstanding bond debt unless Grenada simultaneously makes payments on the defaulted loans. - On March 8, Grenada announced its intention to restructure its public debt. ### Fund policy responses and options to address collective action problems - Potential Fund measures to strengthen restructuring outcomes: - Condition availability of Fund financing more tightly to resolution of collective action problems. - Require high minimum participation thresholds in debt exchange operations launched under Fund-supported programs to ensure broad creditor participation. - Routinely issue statements alerting creditors that securing a critical participation mass in the debt exchange would be required for restoration of external stability—the implication being failure to meet the established minimum participation threshold would block future program financing, leaving default and protracted arrears as the only option. - In pre-default restructurings, set clearer expectations that non-negotiated offers by the debtor—following informal consultations with creditors—rather than negotiated deals, would be the norm given the need for speed to avoid a default. - Rationale: - Fund policy encourages members to avoid default to the extent possible, even after restructuring. - An expectation of eventually being paid out in full may encourage holdouts; high minimum participation thresholds would help reduce such incentives. - Further work: These ideas could be explored in future staff work. ### Credit default swaps (CDS) and their tested impact on restructurings - Current evidence and limits: - The impact of CDS on sovereign debt restructuring is still not fully tested given limited experience in settling such contracts. - Only two examples where the ISDA auction process has been used to determine the recovery rate for sovereign CDS: Ecuador and Greece. - It is too early to provide a conclusive assessment of the CDS settlement impact on the debt restructuring process. - Greece case observations (Box 2): - Sovereign CDS contribute to market efficiency by allowing hedging without changing portfolio composition, but in restructurings CDS buyers may have less incentive to participate voluntarily and may raise holdout incentives. - ISDA Definitions list credit events triggering sovereign CDS: failure to pay, moratorium, obligation acceleration, and restructuring. Either a pre-default debt exchange or a default could trigger a credit event. - For a debt exchange to qualify as a “restructuring credit event,” the exchange generally must bind all creditors, including those voting against the exchange. - Technical issues raised in the Greek CDS settlement: - Timing of exchange vs. timing of CDS auction: - The CDS auction occurred 10 days after the debt exchange; by then old Greek government bonds (GGBs) had been exchanged and were not included among deliverable bonds. - CDS payouts were 78.5 cent per dollar and were closely aligned with losses in the debt exchange, though the text notes this relationship may have been coincidental. - If CDS payouts had been smaller, CDS protection might have been inadequate to cover losses of old GGB holders. - Legal uncertainty of credit event definition: - Certain official measures in the Greek restructuring were not covered by existing ISDA provisions and did not trigger a credit event, increasing negative contingencies and undermining CDS market credibility. - These measures included: (i) removal of old GGBs ahead of the CDS auction; (ii) arbitrary change of covenants of GGBs under domestic law to subject these bonds to a collective action procedure; and (iii) “persuasion” of certain domestic investors to accept large haircuts under a “voluntary” PSI agreement. - Market effects: - Change in Greek bond contracts and timing of CDS auction adversely affected the price of new GGBs. - Price of new GGBs declined as investors and banks were reluctant to buy the bonds without the ability to purchase CDS contracts on the new GGBs. - Financial institutions were unwilling to sell CDS contracts on the new bonds during the 60-day “look-back period”. ### Clarifying the framework for Official Sector Involvement (OSI) - Issues raised by growing role and changing composition of official lending: - Heavy reliance on official lending may inhibit spontaneous market access because private creditors may believe they will be subordinated to official creditors. - Exceptional access criterion: a condition for exceptional access (third criterion) is that the member “has prospects for gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding”. - Question: how to evaluate the market reaccess test of external viability when official lenders make open-ended commitments to support countries until they regain market access (e.g., Greece). - Suggestion: if commitments from official lenders are conditional, they could be linked explicitly to authorities’ efforts to cooperate with the Fund in the context of a program, rather than to ex ante program targets that may evolve over time. - Financing assurances from non-Paris Club creditors: - No specific standard exists for securing program financing commitments from non-Paris Club creditors. - Fund policy of non-toleration of arrears to official bilateral creditors is centered on Paris Club conventions; absence of a Paris Club Agreed Minute requires tacit approval of each official bilateral creditor for Fund financing, leading to uneven practices and safeguards risks. - Consideration needed on adapting Fund policy where a growing number of creditors are non-Paris Club members. ### Historical examples of financing assurances in OSI cases (Box 3) - Poland (1990): Fund required a Paris Club press release in advance of an SBA program review containing specific amount and timing of debt reduction by official creditors. - Egypt (1991): Paris Club issued a press release prior to Fund disbursement; staff report contained language requiring written assurances from creditors for continued support. - Iraq (2004): Managing Director convened Executive Directors representing Iraq’s major creditors to obtain confirmation of language on assurances; press release excerpt acknowledged Fund’s preferred creditor status and creditors’ willingness to make best efforts to provide debt relief and deferrals during the program. - Seychelles (2008): South Africa, a large non-Paris Club creditor, participated in Paris Club negotiations and was a signatory of the Agreed Minutes; Fund required Agreed Minute and staff reports to acknowledge unsustainable debt and include specific timing and amounts of creditor debt reduction. - Greece (2012): Approval of the Greece EFF arrangement relied on a commitment from European partners to “provide adequate support to Greece during the period of the Greek policy program and beyond for as long as it takes to regain market access.” Stronger assurances provided through Eurogroup statements and reflected in Grays of European directors; Grays acknowledged and upheld the Fund’s preferred creditor status. Financing assurances from Euro area member states were less clear in the Greece 2010 SBA which did not envision debt restructuring and a need for OSI at inception. *International Monetary Fund* ### 49. Third, arrears to private and official creditors are currently treated asymmetrically ### 49. Third, arrears to private and official creditors are currently treated asymmetrically ### Asymmetry in treatment of arrears - Private external arrears are tolerated but arrears to official bilateral lenders are not. - This asymmetry exposes the Fund to the risk that it could not assist a member in need due to one or more holdout official bilateral creditors who seek favorable treatment of their claims. - Considerations mentioned: - Extend the LIA policy to official bilateral arrears and clarify modalities through which assurances of debt relief are provided by (non-Paris Club) official lenders. - Paris Club could extend its membership to all major lenders so the Fund could rely on Paris Club conventions for financing assurances and arrears; however, it is uncertain whether the Club could achieve such an expansion. ### Broader stocktaking of the LIA policy - A review of the LIA policy to assess its objectives and effectiveness is warranted given issues that have arisen, in particular in the case of Argentina. - The collaborative, good-faith approach embedded in the LIA policy remains the most promising way to regain market access post-default, but effectiveness and applicability need reassessment given changes in the creditor base. ### Application appears uneven - The LIA policy permits Fund financing to a member in arrears to private creditors provided the member is making good faith efforts to reach a collaborative agreement with its creditors; the policy establishes guiding principles to assess the good-faith criterion. - In four Fund-supported programs reviewed (Dominican Republic, Grenada, Seychelles, and St. Kitts and Nevis), the LIA policy was considered met. - Inconsistencies noted: - Coverage of debtor-creditor relations in Fund staff reports varied; in some cases assessments were cursory. - It was not always clear how adherence to underlying guiding principles of the good faith criterion should be assessed. ### Argentina: questions about LIA effectiveness - Program design and negotiations: - Fund-supported programs in 2003 did not contain a fully quantified medium-term fiscal framework; this was left to negotiation between Argentina and its private creditors, reducing the Fund’s central role in setting the macroeconomic framework and the resource envelope determining terms of debt restructuring. - Creditor engagement and representation: - LIA policy expected authorities to negotiate with creditor committees that were judged to be representative and formed in a timely manner. - There were over thirty creditors’ committees; the Fund assessed that the Global Committee of Argentina Bondholders (GCAB) represented about one-half of Argentina’s external private debt and was therefore representative for LIA purposes. - No constructive dialogue occurred; authorities presented a non-negotiated offer leading to a restructuring of eligible debt and past due interest of about two-fifths of total debt, more than three years after the default. ### Challenges from changes in creditor landscape - Over time creditors have: - Increased in number and become more dispersed. - Adopted different accounting rules (e.g., book value versus mark-to-market). - Displayed different holding patterns and incentives (e.g., short-term creditors versus those holding to maturity), especially when creditors enter the market at different prices. - These developments may make it difficult for any creditor committee to be deemed representative of diverse interests. ### Recent proposals for orderly debt restructurings (overview) - Greek restructuring revived debate and proposals to establish statutory or institutional frameworks to overcome collective action problems and facilitate timely, orderly restructurings. - Notable proposals described: - European Crisis Resolution Mechanism (ECRM): EU-wide statutory, legally binding regime with three building blocks (financial, economic, legal bodies); could impose stay of litigation, enable super-majority cramdown, aggregated voting; key difference from SDRM is no formal Fund role. - Proposal to amend the ESM treaty: amend treaty to immunize a debtor country’s assets from attachment by litigious holdout creditors to minimize litigation risks and deflate holdout expectations; suggests enacting comparable immunities in U.K. and other countries’ domestic law. - Sovereign Debt Tribunal (SDT) / Fair and Transparent Arbitration Process (FTAP): institutionalized or ad hoc arbitration frameworks; SDT a tribunal activated via special clauses in future contracts; FTAP ad hoc with debtor and creditor-appointed arbitrators and a jointly chosen fifth arbiter. - International Debt Restructuring Court (IDRC): UN experts’ proposal for a court ensuring application of agreed international principles, differentiating debt categories, determining “odious” debts, granting authority for “debtor in possession” financing; would be part of a UN-created mechanism with Bretton Woods technical support but independent from those institutions. - Sovereign Debt Forum (SDF): non-statutory, non-institutional neutral standing body for early, discreet consultation and information sharing among distressed sovereigns, creditors, and international institutions; aims to speed return to solvency and build precedent/institutional memory. - Automatic maturity extension proposal: compulsory trigger clause for Euro Area bonds to automatically extend maturities by three years if ESM assistance is granted; extension would not constitute a credit event. - Addendum to the IIF Principles (October 2012): supplements 2006 IIF Principles in light of Greek experience; contains elements contributing to financial stability but includes positions not fully consistent with Fund policies. ### Differences between IIF Principles / Addendum and Fund policy - Notable divergences: - Involvement in DSA: - The Addendum encourages greater involvement of private creditors in setting macroeconomic and policy parameters underlying the DSA. - The Fund welcomes creditor inputs but preserves independence: Fund staff determine the macroeconomic framework and DSA in discussions with the debtor; at the member’s request Fund staff may explain the basis of the framework and DSA to creditors. - Formation and role of creditor committee: - Addendum proposes private creditors organize broadly-based representative creditor committees as early as possible. - LIA policy provides for formal negotiations with a creditor committee only if the case is complex, the committee is representative, and formed on a timely basis; the Fund encourages early, collaborative engagement but leaves committee specifics to debtor-creditor negotiation. - Inter-creditor equity: - Addendum proposes comparable treatment to all creditors and that exceptions be agreed by all creditors. - The Fund seeks adequate fairness to secure participation but leaves the design of restructuring strategy to debtor-creditor negotiations; differentiation in treatment may be acceptable in some cases to limit economic dislocation, maintain market access, and preserve financial stability. - Additional differences: - The Principles call for early negotiations with a creditor committee when default has occurred; the LIA policy requires formal negotiations with such a committee only under certain conditions. - The Principles do not cover voluntary standstills on litigation by creditors represented on the committee, which is included in the LIA policy. - The Principles call for resumption of partial debt service as a sign of good faith; such payments are not a feature of the Fund’s good faith criterion under LIA, where program adjustment and financing parameters determine payment envelopes. - The Principles suggest restructuring from all official bilateral creditors when a sovereign restructures with private creditors; this can be controversial and is not always practiced. - Given these differences, the Fund cannot endorse the IIF Principles and Addendum. ### Monitoring and next steps: issues for discussion - Fund staff monitors developments and applications of the Principles and Addendum and encourages open communication with the IIF. - Four issues identified for possible follow-up work (staff to prepare papers if Directors support): - Better understand why debt restructurings have often been delayed and examine options for making restructurings more timely and effective at restoring sustainability and market access. - Consider options to make the current contractual, market-based approach to debt restructuring more effective in overcoming collective action problems, especially in pre-default cases. - Clarify the framework for official sector involvement in light of the growing role and changing composition of official lending. - Review the effectiveness of the LIA policy given recent experience and increased complexity of the creditor base, while recognizing that the collaborative, good-faith approach remains the most promising path to regain market access post-default. *Source: _042613 - 49. Third, arrears to private and official creditors are currently treated asymmetrically* ### References ### Annex I. Fund Policies on Financing Assurances and External Arrears ### Overview - The Fund’s financing assurances policy and its policy on external payments arrears operate jointly to address balance of payments problems manifested by arrears and to ensure the Fund can be repaid within the medium term. - Burden sharing between official and private creditors is an important element because limits exist on both the degree of policy adjustment by a member and the amount of financing the Fund can provide. - The Fund’s policies seek to align creditor support (new financing, refinancing, or restructuring) with a member’s return to external viability. ### Financing assurances policy: aims and application - Objective: ensure consistency of Fund financing with the member's return to viability to give assurances that the Fund can be repaid within the medium term. - Historical evolution: - Developed in the 1980s when commercial banks were reluctant to spontaneously assist heavily indebted countries. - Initially required specific assurances from other creditors as a prior condition to Fund assistance. - Late 1980s modification allowed approval of an arrangement before banks provided assurances if (i) prompt Fund support is essential, (ii) negotiations between the member and creditors have begun, and (iii) a financing package consistent with external viability is expected within a reasonable period of time. - Practical financing adequacy judgments on approval of an arrangement: - "Firm commitments" of financing must be in place for the first 12 months of the arrangement. - There must be "good prospects" that adequate financing will be available for the remaining program period beyond the first 12 months. - During program reviews, assurances on full financing of successive 12-month periods beyond the initial 12 months must be ascertained; "good prospects" should become "firm commitments" or actual financing. ### Creditor roles and assurances in restructurings - No prescribed allocation between official and private creditors; restructuring is encouraged when gaps cannot be filled with fresh resources. - Bilateral official creditors: - Paris Club participation is treated as financing assurances if an Agreed Minute is expected shortly after approval or completion of a review. - The Fund typically assumes non-Paris Club bilateral creditors will follow Paris Club comparability of treatment. - For large official debt relief operations, additional assurances have included explicit recognition of the Fund’s preferred creditor status, inclusion in the Agreed Minute of timing/amount/modalities of debt reduction, and written assurances of continued financial support. - A significant portion of agreed official debt relief was delivered in tranches upon satisfactory completion of program milestones to preserve incentives for adjustment efforts. - Private creditors: - If private-sector contribution via debt restructuring is needed to restore debt sustainability, the Fund provides financing only with adequate assurances that restructuring will be successful. - Adequate assurances derive from a judgment that a credible restructuring process is underway and will yield sufficient creditor participation to restore debt sustainability within the program’s macroeconomic parameters. ### Arrears policy: principles and scope - General non-toleration of external payments arrears based on destructive effects on national prosperity, the international payments and credit system, and a member’s capacity to repay the Fund. - Legal basis: Article V, Section 3 directs the Fund to adopt policies on the use of its general resources to assist members to solve balance of payments problems and to establish adequate safeguards for the temporary use of Fund resources. - Two guiding principles shaping the policy: - Help members resolve balance of payments problems without resorting to measures destructive of national and international prosperity (Article I(v)). - Ensure adequate safeguards for temporary use of Fund resources by limiting ability to achieve financing through accumulation of arrears. ### Historical extensions and the LIA policy - Original scope (circa 1970) limited to jurisdictional arrears arising from exchange restrictions on current transactions; did not initially apply to government default on external obligations. - In 1980 the policy was extended to include arrears incurred by governments as a result of default. - In 1989 the Fund introduced the policy on lending into sovereign arrears to external private creditors (LIA) as a limited exception to non-toleration of arrears: - Rationale: banks’ unwillingness to provide financing assurances was delaying Fund support; market developments meant many problems reflected sustainability rather than liquidity and could require debt reduction. - LIA allows approval of an arrangement before arrears to external private creditors are eliminated. - LIA applies to lending into sovereign arrears to external private creditors including bondholders and commercial banks as well as nonsovereign arrears stemming from imposition of exchange controls. - LIA does not apply to arrears in dispute; disputed claims accepted by the Fund do not give rise to arrears for all Fund purposes but are taken into account when assessing adequacy of financing assurances. ### Conditions, safeguards, and review under the LIA policy - LIA can be applied on a case-by-case basis and only where: - (i) prompt Fund support is considered essential for successful implementation of the member’s adjustment program, and - (ii) the member is pursuing appropriate policies and is making a good faith effort to reach a collaborative agreement with its private creditors (or to facilitate such an agreement between private debtors and creditors and where a good prospect exists for removal of exchange controls). - Each disbursement under a Fund arrangement subject to a financing assurances review in which the Board considers whether adequate safeguards remain for further use of Fund resources and whether the member’s adjustment efforts are undermined by developments in debt-creditor relations. ### Good faith criterion and procedural expectations - Introduced in 1998 to promote collaborative, timely restructurings and to address coordination difficulties in bond restructurings with heterogeneous and large creditor bases. - Objectives: - Increase likelihood of broad creditor participation needed to normalize creditor–debtor relations and resume market access. - Reduce adverse spillovers of individual restructurings on the asset class and promote efficient capital markets by establishing a more predictable debt-workout process. - Assessment principles: - After determining restructuring is necessary, the member should engage in an early dialogue with creditors until completion of restructuring. - The member should share relevant, non-confidential information with all creditors on a timely basis. - Creditors should be given an early opportunity to give input on design of restructuring strategies and individual instruments. - Procedural expectations vary with case complexity; where an organized negotiating framework is warranted and creditors form a representative committee on a timely basis, the debtor is expected to negotiate in good faith with the committee. - Flexibility is maintained to tailor modalities to case-specific features and to avoid prolonged negotiations that could hamper timely Fund financing. - The Fund retains flexibility to continue to support members even if negotiations stall because creditors request terms inconsistent with program adjustment and financing parameters; private creditors should not have a veto over designing the financing plan or adjustment program. *International Monetary Fund* ### 13. The Fund maintains a policy of non-toleration of arrears to official creditors. Fund- ### _042613 - 13. The Fund maintains a policy of non-toleration of arrears to official creditors. Fund- ### Policy on non-toleration of arrears to official creditors - The Fund maintains a policy of non-toleration of arrears to official creditors. - Fund-supported programs required the elimination of existing arrears and the non-accumulation of new arrears during the program period with respect to official creditors. - In practice, arrears to multilateral creditors are considered resolved if the program provides for their clearance. (Footnote 18: "The debtor authorities must have a credible plan and projected financing to eliminate arrears, but concurrence of the creditor on this plan is not required.") ### Treatment of arrears to the World Bank and other multilaterals - With respect to arrears to the World Bank, upfront clearance of the arrears at the beginning of the Fund-supported program or an agreed plan between the member and the World Bank on terms of clearance over a defined period has generally been required in line with the terms of the 1989 Concordat. (Footnote 19: "Bank-Fund collaboration in assisting member countries.") - Staff has sought the views of the World Bank in all cases where the use of Fund resources was requested by a member with arrears to the World Bank. - A similar approach has been applied to other multilaterals that are expected to provide substantial financing to the program. - The Fund does not have a clear definition of a multilateral institution or an agreed list of multilateral organization. In practice, the Fund judgment on whether an institution is a multilateral creditor is based on a number of factors including: - (i) global, rather than regional, membership of the institution; - (ii) Paris Club's treatment of claims of the institution, and the institution's participation in the Paris Club; and - (iii) the treatment of the institution under the HIPC Initiative. (Footnote 20) ### Evolving practice on arrears to official bilateral creditors - The Fund's practice with respect to arrears to official bilateral creditors has evolved in light of changing circumstances. - Because of the well-established rules and practices of the Paris Club and the Fund staff’s ongoing contacts with the Paris Club, arrears to Paris Club official bilateral creditors covered by the anticipated terms of the Agreed Minute are deemed eliminated for Fund program purposes when financing assurances are received from the Paris Club prior to the approval of a request for use of Fund resources or completion of a review. (Footnote 21: "To the extent that arrears are not rescheduled by the deadline set forth in the Agreed Minute, the arrears are considered to arise new for Fund program purposes, unless the Fund considers that the member has exercised its best efforts to concluding the rescheduling agreement.") - Arrears to non-Paris Club bilateral creditors are similarly deemed eliminated for Fund program purposes as the Fund has relied on the Paris Club’s comparability of treatment principle and assumed that these creditors will restructure the member’s debts on similar terms. - Historically, these conventions were effective because Paris Club debt constituted a large share of official bilateral claims; since the 1990s the Paris Club's share of developing countries' debt and financing flows has been steadily declining and new non-Paris Club bilateral creditors are emerging. ### Tacit approval and application in practice - In cases where there is some official sector concerted action, but falling short of a formal Paris Club Agreed Minute, tacit approval of an official bilateral creditor has been deemed sufficient to satisfy the Fund's arrears policy. - Such tacit approval is generally conveyed through non-objection in the Executive Board to the Fund financial support notwithstanding the arrears. - This approach has been used more commonly in the context of emergency assistance where anticipation has been that such assistance would advance normalization of relations with official bilateral creditors in time for regular treatment in a Fund arrangement. It has also been used in the context of Fund arrangements in a few cases, in the absence of a relevant Paris Club Agreed Minute either because there are no Paris Club creditors involved or the Paris Club share in the arrears is too small. (Footnote 22) *Source: _042613 - 13. The Fund maintains a policy of non-toleration of arrears to official creditors. Fund-* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_042613.pdf_