## The Fund’s Lending Framework and Sovereign Debt (content unit _052214) ## Source details **Canonical URL:** [The Fund’s Lending Framework and Sovereign Debt (content unit _052214)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_052214.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_052214.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_052214.pdf.json) --- ### Executive summary — objectives and core proposal - Follow-up to the Executive Board’s May 2013 discussion; focuses on reforming the Fund’s lending framework, primarily the 2002 Exceptional Access Framework, in the context of sovereign debt vulnerabilities. - Objective: reduce the costs of crisis resolution for creditors and debtors relative to alternatives by broadening policy responses and preserving the Fund’s catalytic role. - Core proposal: introduce greater flexibility by permitting, in specific cases, a debt operation that extends maturities without principal or interest reduction (“reprofiling”) coupled with a credible adjustment program when debt is assessed to be sustainable but not with high probability. ### Nature of the problem and rationale for change - Central feature of the 2002 framework: exceptional access requires a determination that “there is a high probability that the debt will remain sustainable.” - Consequences: where that high-probability determination cannot be made, a sufficiently deep debt restructuring (significant NPV reduction) has been required. - Problem: forward-looking DSAs are judgmental and often leave considerable uncertainty; requiring definitive debt reduction in such cases can impose unnecessary costs on creditors, sovereigns, and global financial stability. - 2010 systemic exemption found to be both too narrow and too broad; proposed elimination on equity and effectiveness grounds. ### Reprofiling — design and intended role - Reprofiling defined: relatively short extension of maturities, normally without reduction in principal or coupon, of limited duration, designed to improve prospects of restoring market access when sustainability is uncertain. - When appropriate: - (a) the member has lost market access; and - (b) a complete DSA indicates debt is sustainable but not with high probability (i.e., insufficient confidence to conclude either sustainability or unsustainability). - Typical operational parameters: - Reprofiling period would normally not exceed three years. - Interest payments continue; principal servicing deferred for the reprofiling period. - Duration and scope determined case-by-case taking program length and debt structure into account. - Safeguards: - Reprofiling is voluntary and market-based; creditor agreement necessary (typically via exchange). - Not to be used where DSAs indicate debt is unsustainable—definitive debt reduction remains appropriate. - Repeat reprofilings avoided; failure of a reprofiling to dispel sustainability concerns would require a debt reduction. ### Criteria, scope, and interactions with Fund programs - Market access assessment: judgmental, case-by-case; excludes market indicators (e.g., current sovereign spreads) from the DSA to avoid self-fulfilling losses of market access. - Scope considerations: - Likely necessary that similar claims held by residents and nonresidents be covered. - Possible exclusions: treasury bills to preserve functioning of financial markets. - Claims falling due outside the reprofiling period may or may not be extended depending on inter-creditor equity and “wall” of maturities concerns. - Reprofiling limited to sovereign debt (debt contracted or guaranteed by the general government). - Official bilateral creditors: - Expected to maintain exposure, consistent with Paris Club practice; net exposure could be maintained via provision of new financing. - Exception: if the vast bulk of debt service during the program period is held by official creditors and private creditor payments are small, reprofiling private claims may not be cost-effective. - Program design and timing: - Reprofiling should not delay Fund support; debt operations can sometimes be completed within 90 days. - Interim financing may be provided with program approval based on a credible commitment to complete reprofiling by a specified review. - Conserved resources from reprofiling can allow a less constraining adjustment path, supporting growth and program success; caveat for very heavily indebted members. ### Creditor engagement, legal/contractual issues, and collective action - Creditor consultation: - Member must undertake adequate creditor consultation prior to initiating an exchange; Fund staff can, at member’s request, explain DSA analysis and judgment. - Creditor committees may play a role where broad representation is possible. - Collective action and participation incentives: - High participation in exchanges is imperative; creditors will participate only if reprofiling is preferable to alternatives (default and/or debt reduction). - Techniques to mitigate holdouts: minimum participation thresholds (up to 90 percent), CACs, exit consents. - Contractual context: - Approximately US$1.2 trillion of foreign law bonds outstanding; about 25 percent of these do not include CACs. - New York law bonds: about US$500 billion outstanding; about 20 percent or US$100 billion do not include CACs. - Domestic-law bonds typically lack CACs but can be restructured under domestic law. - Legal risks: U.S. court interpretation of the pari passu clause (Argentina litigation) may increase holdout leverage; contractual revisions and aggregation clauses are under discussion but would take about 10 years for the stock of bonds to turn over. ### Comparative costs and benefits — empirical indicators and indicative findings - Comparative scenarios: - Reprofiling vs debt reduction: reprofiling generally imposes smaller NPV losses on creditors, may enable quicker return to markets and less disruption to domestic financial systems; risk of prolonging debt overhang if misused. - Reprofiling vs bail-out with later restructuring: reprofiling preserves resources, allows less-constraining adjustment, and can reduce eventual haircut needed if restructuring later occurs. - Reprofiling vs creditor exit when restructuring not needed: outcomes depend on market reaction; used only after loss of market access to limit self-fulfilling dynamics. - Empirical findings (indicative, not definitive): - Time to market reaccess (global bond issuance definition): - Reprofiling cases: median = 35 months. - Restructuring cases: median = 57 months. - Time to market reaccess (spreads normalization definition): - Reprofiling cases: median = 8 months. - Restructuring cases: median = 35 months. - Observations: face-value preserving maturity extensions associated with faster spreads normalization and shorter durations to reaccess relative to deeper NPV-reducing restructurings; classification limitations noted. ### Contagion and systemic exemption - Proposal: eliminate the 2010 systemic exemption to the 2002 framework. - Rationale: exemption perceived as inequitable, excessively open-ended, and ineffective in addressing contagion; uncertainty exacerbates contagion. - Recognized exceptional circumstances where special responses may be required: - Currency unions with highly interconnected financial markets: system-wide backstops and firewalls. - Members of sufficient systemic importance where any restructuring risks a systemic crisis; alternative approaches may be needed. - Legal constraint: the Fund cannot provide financing without regard to debt sustainability; systemic exemption cannot dispense with sustainability requirement. - Alternatives when contagion concerns are acute: seek concessional support from other official creditors or expect other official creditors to provide financing, with attendant moral hazard considerations. ### Design safeguards and ex ante effects on markets - Decision rule remains case-by-case and non-automatic: - High probability of sustainability → traditional catalytic financing without reprofiling. - High probability of unsustainability → require sufficiently deep debt reduction for exceptional access. - Uncertainty between these outcomes → reprofiling may be appropriate. - Ex ante effects: - Little likely effect on steady-state borrowing costs; steady-state costs driven primarily by sovereign creditworthiness. - In distress, elimination of systemic exemption could lead creditors to demand higher rates (especially on short-term debt) when sovereigns enter distress, improving risk pricing and incentivizing earlier corrective policy action. ### Box 3 — Impact of maturity extensions on domestic bank balance sheets (indicative case findings) - Assessment methodology: reviewed staff reports and sources to determine whether bond exchanges caused banks to require additional provisioning or recapitalization. - Enabling conditions that limited banking-sector impact: - Domestic holdings classified as held-to-maturity (HTM). - Limited size of exchanges. - Short-lived rating downgrade to Selective Default (SD) in most cases (exception: Pakistan with 11 months). - Regulatory incentives to participate and capital/liquidity support mechanisms. - Case summaries: - Cyprus (2013): exchange of bonds ahead of maturity; HTM classification and lack of payment default avoided immediate bank losses; temporary SD not treated as impairment. - Jamaica (2010, 2013): limited-size exchanges; HTM holdings and regulatory incentives; FSSF not tapped. - Pakistan (1999): limited impact; 30 percent of restructured bonds held by domestic investors; SD lasted 11 months; one bank received capital injection 6 months later unrelated to exchange. - Uruguay (2003): small immediate direct impact; domestic holdings mostly retail and HTM; bank supervisor provided regulatory incentives. - Summary conclusion: under observed conditions, past maturity extensions did not force immediate provisioning or recapitalization of banks as a direct consequence of the exchanges. ### Issues for Board consideration and next steps - Views sought on: - Whether the 2002 exceptional access framework poses undue constraints and support for proposed modifications. - Whether the 2010 systemic exemption should be eliminated and, if extreme cases arise, whether alternative approaches are appropriate. - Agreement with design and implementation elements for reprofiling and the proposed limitation on repeated reprofilings in normal access cases. - Follow-up work proposed on clarifying the market access criterion (exceptional access Criterion 3) and on modalities for creditor engagement, contractual reform implications, and techniques to encourage broad creditor participation. *International Monetary Fund. Chapter excerpt on the Fund’s lending framework and sovereign debt (content unit _052214).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Background - Follow-up to the Executive Board's May 2013 discussion. - Focus: possible direction for reform of the Fund's lending framework in the context of sovereign debt vulnerabilities, primarily the Fund's exceptional access framework. - Objective of preliminary approaches: reduce the costs of crisis resolution for both creditors and debtors—relative to the alternatives—thereby benefitting the overall system. - Ideas are market-based and would require meaningful consultation with creditors. ### Nature of the problem - The Exceptional Access Framework established in 2002 (“2002 framework”) limits the range of policy responses when a member seeks financing above normal access limits in a sovereign debt crisis. - Under the 2002 framework: - If the Fund determines that the member’s debt is sustainable with high probability, it may provide large scale financing without a debt restructuring. - If such a determination cannot be made, exceptional access may only be provided if a debt restructuring is pursued that is sufficiently deep to restore sustainability with high probability. - The 2002 framework was designed to address moral hazard and the cost of delaying restructuring, but it also created scope for unnecessary costs for both debtor and creditors by requiring a definitive debt restructuring even where it might not be needed. - Historical context: prior to 2002 the exceptional access policy was very flexible; exceptional access was granted 14 times between 1995 and 2002, prompting concerns about moral hazard and adequacy of safeguards. ### Possible remedy - Introduce greater flexibility into the 2002 framework by broadening the range of potential policy responses in sovereign debt distress while addressing the original concerns motivating the 2002 framework. - Where a member has lost market access and debt is considered sustainable, but not with high probability, the Fund could provide exceptional access on the basis of a debt operation involving an extension of maturities (normally without any reduction of principal or interest). - Such a “reprofiling” operation, coupled with a credible adjustment program, would be designed to improve prospects of securing sustainability and regaining market access without meeting the criterion of restoring debt sustainability with high probability. ### Safeguarding the catalytic role - No presumption that a reprofiling would be required solely because a member seeks Fund support. - A reprofiling would be envisaged only when both: - (a) a member has lost market access; and - (b) debt is assessed to be sustainable, but not with high probability. - If a member’s debt is unsustainable, a reprofiling would be inappropriate and an upfront debt reduction operation would be pursued, as under current policy. - Repeat reprofilings would be avoided: a debt reduction would be called for if a reprofiling operation failed to dispel concerns regarding debt sustainability. ### Benefits - Where there is considerable uncertainty as to whether debt is sustainable or unsustainable, a reprofiling will generally be less costly to the debtor and creditors—and thus to the system overall—relative to either an upfront debt reduction operation or a bail-out followed by debt reduction. - Relative to a bail-out, financing provided through reprofiling could allow for more gradual adjustment paths, helping growth, reducing economic dislocation and facilitating successful program implementation. ### Securing creditor support - Reprofiling would be market-based and require sovereign’s creditors to agree to amend instruments to extend maturities. - Creditors will only agree if they understand such amendment is necessary to avoid a worse outcome (default and/or debt reduction). - Requires consultation with creditors, including explanation of assumptions underpinning the member’s debt sustainability analysis. - Collective action clauses (now in most—but not all—bonds) would be relied upon to address collective action problems. - Official creditors would be expected to maintain their exposure either through an extension of maturities or provision of new financing. ### Systemic exemption - Under the possible modifications, the systemic exemption to the 2002 framework introduced in 2010 would be eliminated. - Reasons: - The exemption is perceived to be inequitable and excessively open-ended. - Experience demonstrates that contagion is exacerbated by uncertainty; a large scale bail-out that fails to address sustainability will not mitigate contagion risks. - Recognized exceptions: where any form of debt restructuring would be problematic from a contagion perspective, sustainability concerns could be addressed through concessional assistance provided by other official creditors. ### Ex ante effects - Revised framework would continue to rely on case-by-case judgments on whether debt is sustainable or unsustainable; impact depends on application in practice. - Unlikely to affect countries’ steady-state borrowing costs, since investors tend to rely primarily on borrower creditworthiness when pricing risk. - In the context of debt distress for a particular member, creditors may demand higher rates on shorter-term debt if they perceive the modifications reduce the probability of a bail-out; this could lead to better pricing of risk. ### Normal access - Many benefits from reprofiling may apply in normal access cases where debt sustainability is in doubt, but the paper does not consider making reprofiling a requirement in normal access uncertainty cases. - Suggests establishing a policy to avoid repeated use of reprofilings in normal access cases, consistent with the approach for exceptional access. - If a reprofiling does not work, a definitive solution (debt reduction) would be called for. *May 22, 2014 — Executive Summary of “The Fund’s Lending Framework and Sovereign Debt”* ### 7. Central to the 2002 exceptional access framework is the requirement that “a rigorous ### _052214 - 7. Central to the 2002 exceptional access framework is the requirement that “a rigorous ### Background and problem statement - Central 2002 exceptional access requirement: “a rigorous and systematic analysis indicates that there is a high probability that the debt will remain sustainable.” - Two consequences of this requirement: - The Fund may rely on its traditional catalytic approach only where it is very confident there is a high probability that the member’s debt is sustainable; uncertainty about sustainability therefore often implies debt restructuring will be required. - Where debt restructuring is determined necessary, it must be sufficiently deep to enable the Fund to conclude that, post restructuring, there is a high probability that the member’s debt will become sustainable—i.e., a definitive debt operation entailing a significant reduction in the net present value of claims. - Debt sustainability assessments (DSAs) are forward-looking and judgmental; even with improvements to the DSA framework noted in the 2013 paper, there will be instances where it is difficult to conclude a high probability of either sustainability or unsustainability. - Costs of insisting on deep restructuring in cases of uncertainty: - Creditors: loss in the net present value of claims and possible spillovers to other sovereign bonds or asset classes. - Sovereign: loss of market access over the medium term; financial sector disruptions, especially where domestic banks hold sovereign debt. - Global financial stability: risk of contagion. - The 2010 systemic exemption: amended 2002 framework to allow waiving the “high probability” determination where there is a “high risk of international systemic spillovers.” - Identified shortcomings: exemption is both too narrow (only helps sufficiently large/interconnected members) and too broad (does not address the costs of anticipating use of Fund and member resources to repay private creditors and can aggravate member and Fund risks). ### Possible remedy: greater flexibility and reprofiling - Objective of reform: enable the Fund to (i) help members improve capacity to service debt without necessarily requiring significant debt reduction while (ii) avoiding programs that allow eventual full repayment of maturing obligations to private creditors when sustainability is in question. - Key elements of the approach considered: - Eliminate the 2010 systemic exemption. - Where a member has lost market access and public debt is considered sustainable but not with high probability, the Fund could make financing conditional on a debt operation that improves sustainability without necessarily restoring it with high probability. - Primary proposed instrument: relatively short extension of maturities (“reprofiling”), typically not involving reduction in principal or coupon and of limited duration—hence not implying a significant reduction in the net present value of creditors’ claims. - Reprofiling is designed to, together with a strong adjustment program, provide good prospects of restoring market access without debt reduction. Duration of reprofiling determined case-by-case, considering program length and debt structure. - If reprofiling proves insufficient during the program, further Fund support would be conditioned on a more definitive debt operation. - Preservation of traditional catalytic approach: - No presumption that a member who lost market access must restructure. - Fund can still rely on catalytic approach when it determines with high probability that debt is sustainable. - Definitive debt reduction remains appropriate where DSAs indicate debt is unsustainable. - Voluntary nature and creditor incentives: - Reprofiling depends on creditor agreement (normally via an exchange) to extend maturities. - Collective action clauses that allow a qualified majority to bind the minority will be important to address holdout problems. - Creditors will only participate if they judge it in their interest; securing adequate participation requires credible Fund-supported program, credible reprofiling size (financing envelope), and clarity that insufficient participation will block the program. ### Costs and benefits of reprofiling (comparative scenarios) - Reprofiling as an alternative to debt reduction when sustainability is uncertain: - Likely lower cost than debt reduction because: - Smaller impact on net present value of creditors’ claims → less disruption to domestic financial institutions and foreign holders. - Sovereign likely to return to capital markets more quickly after reprofiling than after debt reduction. - Risks: - Market perception that only debt reduction can restore sustainability could produce adverse reactions to reprofiling. - Reprofiling risks prolonging the debt overhang problem; should not be used when debt is unsustainable. - Reprofiling as an alternative to allowing creditor exit when debt reduction proves necessary: - Benefits to member: retained resources that would otherwise be paid out to maturing creditors, reducing overall financing needs or enabling a less constraining adjustment path and supporting growth. - Benefits when debt reduction later occurs: haircut needed may be reduced because of a larger creditor base; longer-term creditors share burden. - Benefits to Fund: reduced financing required during program; when debt reduction occurs, member in stronger position to regain financial stability and external viability. - Systemwide benefit: reprofiling may mitigate moral hazard associated with bailouts and reduce incidence of future crises. - Reprofiling as an alternative to allowing exit when debt reduction is not needed but uncertainty exists: - Costs: triggers credit event and rating downgrade, which would otherwise be avoided if ex post payment was correct. - Benefits depend on market dynamics: if reprofiling plus less-constraining adjustment convinces investors, market reaccess prospects improve; if markets disagree, reprofiling can signal worse prospects and lead to higher spreads. - Risk mitigation: reprofiling would be used only after market access is lost, so market has already formed a negative assessment. ### Empirical evidence and indicative findings (as summarized) - Review of past cases suggests indicatively that: - Sovereign spreads have risen less, and returned to precrisis levels faster, in past face-value preserving maturity extensions compared to debt reductions (see Figures referenced). - Credit rating downgrade to selective default has been short-lived in such operations, corresponding to the duration of the exchange offer. - It appears to have taken longer, in general, for a member to re-access markets after a debt reduction than following moderate face-value preserving maturity extensions. - Impact on domestic financial systems has been limited in past face-value preserving maturity extensions. - Caveats: - These findings are not definitive—market responses depend on many factors beyond degree of NPV reduction. - Face-value preserving maturity extensions were used as a proxy for reprofilings; classifications are imperfect because restructurings lie on a continuum of NPV impact. - Reprofiling should be applied only when it has a credible prospect—together with policy adjustment—of resolving the member’s problems. *International Monetary Fund. Chapter excerpt on the Fund’s lending framework and sovereign debt (content unit _052214).* ### 2005. In this regard, time to market reaccess based on spreads normalization may not represent the actual impact of the ### _052214 - 2005. In this regard, time to market reaccess based on spreads normalization may not represent the actual impact of the ### Reprofiling as a policy tool vs debt reduction - Reprofiling’s key objective is to reduce the likelihood that a further debt restructuring is needed (para. 17). - Compared with programs that allow repayment of maturing obligations, a program accompanied by a reprofiling: - Is likely to have a greater chance of program success by facilitating a less constraining and more politically palatable adjustment path (para. 17). - Can improve the debt profile and hasten return to market access (para. 17). - Evidence: when initial debt levels are moderate, a light restructuring can effectively address the debt problem (para. 17; Annex II reference). - Creditors’ contribution through reprofiling may help catalyze domestic support for adjustment (para. 17). - Reprofiling was supported under normal access programs and outside the 2002 exceptional access framework where flexibility allowed support even when sustainability was not resolved with a high probability (para. 18). ### Historical usage and evolution - Maturity extensions and reprofilings were common during the 1980s debt crisis; these early reschedulings facilitated eventual debt reduction (Brady Plan) while limiting costs to financial stability (para. 19). - The evolution of capital markets and many bondholders requires a different approach to designing and implementing reprofiling strategies compared with bank-dominated regimes (para. 19). ### Risks and safeguards - Main risk: additional flexibility could be used to delay debt reduction that is already necessary (para. 20). - Reprofiling is intended only where there is considerable uncertainty about sustainability; where debt is clearly unsustainable, reprofiling is insufficient and debt reduction is necessary (para. 20). - Incentives among sovereign debtors, private creditors, and official sector members can align to delay debt reduction (para. 20). - Operational safeguard: the Fund would normally not support successive reprofilings for both exceptional and normal access programs to avoid prolonged delays in necessary debt reduction (para. 20). ### Empirical evidence: time to market reaccess and NPV reduction (figures from charts) - Reprofiling cases (time to reaccess defined based on global bond issuance): median = 35 months. - Examples shown: Pakistan '99; Moldova '02; Uruguay '03; Dom. Rep.'05; Grenada '04; Belize '06. - Corresponding horizontal axis labeled: Time to Market Reaccess (in months); vertical axis labeled: NPV reduction with percentage scale starting 0% up to 40%. - Restructuring cases (time to reaccess defined based on global bond issuance): median = 57 months. - Examples shown: Argent.' 05; Seychel. '10; Ecuador '00; St. Kitts '12; Greece'12; Russia '98. - Corresponding percentage scale for NPV reduction from 30% up to 80%. - Reprofiling cases (time to reaccess defined based on spreads normalization): median = 8 months. - Examples shown: Pakistan '99; Uruguay '03; Dom. Rep.'05; Belize '06. - Percentage scale for NPV reduction from 0% up to 40%. - Restructuring cases (time to reaccess defined based on spreads normalization): median = 35 months. - Examples shown: Argent.' 05; Russia '98; Ecuador '00; Seych. 08. - Percentage scale for NPV reduction from 30% up to 80%. - Note: source shows specific country datapoints across these four panels; medians reported above are taken directly from the figures as presented. ### Addressing contagion concerns - No “systemic contagion exemption” should shield a member from reprofiling when sustainability is uncertain; such an exemption raises equity, moral hazard, and safeguards concerns (para. 22). - Reasons a systemic exemption would be neither necessary nor desirable (para. 23): - Reprofiling has more limited NPV impact than debt reduction, reducing balance-sheet spillover risk (para. 23, bullet 1). - Credible, prompt reprofiling decisions that address a member’s debt problems and build financial system firewalls can cause contagion to abate (para. 23, bullet 2). - Deferring recognition of sustainability problems by exempting contagion-linked cases would be counterproductive and promote moral hazard (para. 23, bullet 3). - Recognized exceptional circumstances where special responses may be required (para. 24): - Currency unions with highly interconnected financial markets: limit contagion using system-wide backstops and prompt strengthening of firewalls (para. 24, bullet 1). - Cases of members of sufficient systemic importance where any restructuring could risk triggering a systemic crisis; membership may conclude delaying restructuring could be less costly (para. 24, bullet 2). - Legal and practical constraints: - The Fund is legally precluded from providing financing to address systemic risk without regard to the member’s debt sustainability; a systemic exemption cannot dispense with the sustainability requirement (para. 25). - Alternatives when contagion concerns are acute (para. 26): - Seek assurances of concessional support from other official creditors to address sustainability without restructuring; drawback: exacerbates moral hazard and distributes burden beyond the member (para. 26, bullet 1). - Other official creditors provide financing on their own (non-Fund), potentially without concessionality; drawbacks include moral hazard and delayed restructuring (para. 26, bullet 2). - Executive Board could amend the exceptional access framework to create a systemic exemption by majority vote (para. 27), but policy analysis suggests such an exemption would not effectively address contagion (para. 27). ### Potential ex ante effects on borrowing costs and market dynamics - Reforms’ likely effect on “steady state” borrowing costs is limited: steady-state costs are driven primarily by perceived sovereign creditworthiness rather than Fund policy design; market outreach indicated impact depends on discretionary application (para. 28). - Possible impact during distress: - Elimination of the systemic exemption could lead creditors to demand higher rates when a sovereign enters distress because of a greater perceived possibility of restructuring; short-term debt rates may be particularly affected (para. 29). - This could improve risk pricing and encourage earlier corrective measures and policy action by sovereigns with weak fundamentals, reducing the likelihood of eventual restructuring (para. 29). ### Design and implementation: decision rule for reprofiling - Amended exceptional access policy would continue to require case-by-case assessment and no automaticity (para. 30). - Decision rule (para. 31): - If the Fund has “high probability” confidence that debt is sustainable → rely on traditional catalytic role to enable servicing original claims. - If the Fund has “high probability” confidence that debt is unsustainable → exceptional access only if member seeks sufficiently deep debt reduction to establish clear sustainability. - Reprofiling is appropriate only where the Fund lacks sufficient confidence to make either of the above determinations (i.e., where there is uncertainty). *Source: Excerpts from THE FUND’S LENDING FRAMEWORK AND SOVEREIGN DEBT (International Monetary Fund).* ### 32. In light of the above, a key issue will be to identify the general criteria that would ### _052214 - 32. In light of the above, a key issue will be to identify the general criteria that would ### Criteria for when reprofiling is appropriate - Two conditions required before the Fund determines that a reprofiling should take place as a condition for exceptional access: - First, the member must have already lost market access. - Market access assessment requires judgment and case-by-case evaluation of whether the member can tap international capital on a sustained basis through contracting of loans or issuance of securities across a range of maturities (in both local and foreign currencies) at interest rates compatible with reasonable medium term growth rates and an achievable primary fiscal position. - Types of indicators used for assessing market access are summarized in Box 6 (in the source). - Second, a complete DSA must suggest there is considerable uncertainty regarding debt sustainability and whether the loss of market access will be temporary. - No predefined indicator thresholds; Fund staff assess DSA indicators to judge whether there is a high probability of either sustainability or unsustainability. - Reprofiling is called for only where it is not possible to reach either conclusion. - To avoid a self-fulfilling loss of market access, market-related indicators (e.g., current sovereign spreads) would be excluded from this DSA analysis. - The DSA would be based on a program that includes policy measures necessary to strengthen the sovereign’s financial position, directly or indirectly (for example, bank restructuring where bank creditors absorb insolvency costs). - Design considerations for criteria: - Ensure Fund’s catalytic role is not undermined and avoid any perception of a “presumption” that exceptional access will always be accompanied by reprofiling. - Avoid relying exclusively on market indicators to prevent self-fulfilling market access losses. - Executive Board guidance would be sought prior to initiating discussions on an exceptional access program; Directors have an early opportunity to comment on preliminary DSA and market access assessments. ### Length of reprofiling period and scope of debt to be covered - Reprofiling period design: - Reprofiling would allow deferral of principal servicing (interest would continue to be paid) for a period that would normally not exceed three years (the “reprofiling” period). - Precise length could vary depending on specifics of the Fund-supported program and the maturity structure of claims. - Scope of debt considerations: - Objectives: - Give authorities sufficient breathing room for adjustment policies to take hold. - Address inter-creditor equity so creditors are willing to participate. - Take financial stability into account while preserving prospects for debt sustainability. - Likely necessary that similar claims held by residents and nonresidents be covered. - Possible exclusions: treasury bills may be excluded to preserve functioning of financial markets. - Claims falling due outside the reprofiling period may or may not be extended depending on circumstances (inter-creditor equity, avoiding a “wall” of maturities). - Fund would not micromanage specifics; as long as reprofiling had sufficient creditor participation to deliver necessary financing and preserve financial stability, authorities and advisors design operation specifics. - Reprofiling scope limited to sovereign debt (debt contracted or guaranteed by the general government); non-sovereign debt restructuring achieved through domestic legal framework. - Official bilateral creditor treatment: - Reprofiling expected to maintain exposure of official bilateral creditors (Paris Club practice cited). - For non-Paris Club official creditors, Fund would need adequate financing assurances clarifying magnitude, timing and modalities of debt relief. - Net exposure of an official creditor could be maintained via provision of new financing. - Private sector participation more likely where there is adequate burden sharing between private sector and official bilateral creditors. - Exception where private creditor reprofiling not cost-effective: - If the vast bulk of debt service during program period is held by official creditors and scheduled payments to private creditors are sufficiently small, reprofiling private claims may not be cost-effective. - Adequate financial commitments by official creditors can suffice for Fund support without private sector participation. - If uncertainty persists: - No automatic conversion to a debt reduction operation. - Expectation that deeper debt reduction would be needed if debt outlook does not improve, because: - Program failure would suggest underlying debt problems are more severe. - Having asked creditors to reprofile once, it would be inappropriate to ask them to do so again; a more definitive debt restructuring would be appropriate. ### Design of the Fund-supported program with reprofiling - Advantages of reprofiling: - Enables Fund to support a less constraining adjustment path with greater chance of securing debt sustainability. - Conserved resources through reprofiling could finance a more evenly-phased adjustment path, making the program less procyclical and limiting hysteresis effects. - By easing the balance-of-payments constraint, reprofiling could avert an unduly sharp exchange rate depreciation that could aggravate public and private debt burdens. - Caveat: Not advisable for the most heavily-indebted members; conserved resources may be better used to reduce overall scale of program financing. - Timing and interim financing: - Reprofiling should be designed so it does not delay Fund support. - Debt restructuring operations can sometimes be completed within 90 days. - If reprofiling cannot be completed prior to program approval and urgent assistance is needed, the Fund may provide interim financial support. - The arrangement could be approved—and the first purchase made available—based on a credible commitment that reprofiling will be carried out by a specified review. - Program parameters define the financing amount expected from reprofiling and anchor consultations between sovereign and creditors. ### Securing creditor support - Implementation principles to garner broad creditor support: - Implement reprofiling in a manner that, to the extent possible, avoids a payment default—extensions should occur while the debtor continues to service claims. - Avoiding payment default is important because a default could exacerbate financial instability and hinder return to market access. - In cases where an arrangement is approved prior to reprofiling completion, the Fund would normally indicate a subsequent review will not be completed until reprofiling is successfully concluded (example: Uruguay). - Anticipated market/legal consequences and mitigation: - Reprofiling will most likely trigger a credit event under ISDA contracts (likely activation of collective action clauses) and likely result in a credit downgrade among rating agencies. - Since these events occur after the member has lost market access, the disruptive effect is limited. - If reprofiling is successful and the member implements the program, sovereign pricing and ratings typically improve (rating may emerge from Selective Default). - Creditors’ incentives to participate: - Majority of sovereign debt is in bond form; reprofiling would largely be effected through bondholders agreeing to extend maturities, most likely via a bond exchange. - High participation rate in the exchange is imperative to deliver needed financing and avoid a payment default. - Creditors will participate only if they perceive participation is preferable to the alternative. They must be persuaded that: - (i) there is a serious risk the member may not be able to service claims, leading to a payment default and debt reduction operation, and - (ii) reprofiling coupled with Fund-supported adjustment policies will significantly increase chances of avoiding a payment default and debt reduction operation. - Reprofiling must only be used after the market has already judged the risks (i.e., after loss of market access). - Program must provide a viable path to sustainability; if creditors perceive reprofiling is merely the opening stage of an inevitable debt reduction, they will withhold participation. *Source: _052214 - 32.* ### 46. In light of the above, obtaining creditor support will require adequate creditor ### _052214 - 46. In light of the above, obtaining creditor support will require adequate creditor ### Creditor consultation and engagement - Member must undertake adequate creditor consultation prior to initiation of an exchange; Fund staff ready to explain need for reprofiling and why the Fund-supported program stands the best chance of avoiding a debt reduction. - Form of consultation will vary by circumstances; Fund staff should, at the member’s request, explain the analysis and judgments underpinning the conclusions of the DSA so creditors can make informed decisions. - Market participants conveyed a strong desire for a more meaningful creditor engagement process and emphasized greater reliance on creditor committees when committee composition is sufficiently broad to represent the creditor body. - Acknowledgement that high participation has been achieved in several cases without creditor committees; modalities for creditor engagement in pre- and post-default cases to be discussed in a subsequent staff paper. ### Design and implementation of reprofiling (financing and instrument choices) - If the exchange delivers needed financing relief during the reprofiling period, the Fund would not micromanage or be prescriptive about instruments offered; authorities and their advisors determine whether to reprofile claims outside the reprofiling period for inter-creditor equity or other purposes (e.g., bunching of maturities). - Determinations needed on whether claims falling due within the reprofiling period should be extended by the same amount; treatment may differ for claims falling due at the beginning vs. the end of the reprofiling period. - Collective action clause design will affect how these issues are resolved. - Consideration of limited Fund resources to provide incentives to creditors to participate in a reprofiling, drawing on techniques from the 1980s: - Late 1980s policy: portion of the member’s access set aside and released at the conclusion of the debt operation to collateralize interest payments on newly issued Brady bonds during the program period. - Possible variation: collateralization of a portion of interest payments on reprofiled instruments to improve trading value, reduce investor losses, and facilitate earlier market reaccess. - Costs and benefits of such enhancements will be discussed in a follow-up paper. ### Techniques to address collective action problems - Identified collective action concerns: free rider problems and holdouts who may be paid under original terms or sue for full payment. - Historical context: 1980s negotiations among a limited number of banks under regulatory suasion; modern markets have large, diverse groups of bondholders including secondary-market purchasers seeking full recovery. - Techniques developed to mitigate collective action problems: - Imposing a minimum participation threshold in a debt exchange; threshold can be as high as 90 percent. - Inclusion of “collective action clauses” (CACs) in bond contracts governed by foreign law to bind a qualified majority of creditors of a particular issuance to restructuring terms. - Out of the approximately US$1.2 trillion foreign law bonds outstanding, about 25 percent do not include collective action clauses. - Of a total outstanding stock of New York law bonds of about US$500 billion (about 40 percent of all issuances), about 20 percent or US$100 billion do not include collective action clauses. - Domestic-law bonds typically do not feature CACs, but sovereigns can restructure these given their power to change domestic law. - Use of exit consents to change certain nonpayment terms in existing bonds (e.g., financial covenants) by a consenting majority to encourage holdouts to participate; successfully used in Uruguay and other cases. - Limitation: CACs and exit consents typically bind only holders of the same issuance; a holdout can neutralize such clauses by obtaining a blocking position (normally over 25 percent) of an issuance. ### Contractual risks from litigation and potential contractual reforms - U.S. court interpretation (Argentina litigation) of the pari passu clause has been read to require full payment to a defaulted claim if any payments are made on restructured bonds, increasing holdout leverage and complicating restructurings. - If upheld (currently on appeal to the U.S. Supreme Court), implications include: - Discouraging creditor participation in voluntary restructurings by allowing holdouts to interrupt payments to participating creditors. - Increasing the risk that holdouts multiply and reducing willingness to agree to restructurings due to inter-creditor equity concerns. - Discussions underway to modify sovereign bond contracts to limit impact of these decisions: - Growing consensus that pari passu provision should be amended to preclude the court interpretation reached. - Ongoing discussions on designing a more robust “aggregation” clause for collective action. - Even if amended provisions are introduced into new bonds, it would take approximately 10 years for this stock to be replaced. - Therefore, it would not be appropriate to make the outcome of Fund lending framework discussions contingent on contractual revisions. - A broader review of the implications of the court decisions on the restructuring process will be needed in the near to medium term (i.e., during the period before the outstanding stock has been replaced by revised contractual provisions). ### Implications for normal access framework and repeated reprofilings - Staff does not propose making reprofiling a requirement for normal access programs when debt sustainability is in doubt. - Current policy: for programs within normal access limits, debt restructuring is not required except when debt is assessed to be unsustainable. - Where uncertainty exists on sustainability, the Fund can choose the catalytic approach or require some form of debt operation (reprofiling or debt reduction). - This latitude reflects lower financial risks to the Fund when access is within normal limits and is recommended to continue. - Concern: latitude in normal access cases could be misused to pay private creditors with Fund resources when prospects for debt sustainability are uncertain. - Staff suggests establishing a policy to limit repeated use of reprofilings in normal access cases, similar to considerations under exceptional access: - Repeated reprofilings within some defined period would signal debt unsustainability and impede program success. - If a reprofiling together with the program is not sufficient to restore debt sustainability and market access, continued Fund support under normal access should be conditioned on a definitive debt operation. ### Clarifying the market access criterion (exceptional access Criterion 3) - Proposal for follow-up staff work to clarify the third exceptional access criterion: “the member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding.” - Underlying assumption: regaining market access is needed for medium-term sustainability and Fund repayment. - Questions raised by recent euro area experience about evaluating this criterion when official lenders make open-ended commitments (e.g., Greece). - Need to clarify the time frame in which market access must be established to satisfy the criterion. - Clarifications would also be relevant where official creditors provide concessional support as described in Section II.D. ### Issues for Board discussion (excerpt) - Views requested on: - Whether the exceptional access framework established in 2002 poses undue constraints on the Fund’s ability to respond in an appropriate and least-cost manner. - Support for possible modifications to the exceptional access framework described in Section II.B. - Whether the existing systemic exemption established in 2010 should be eliminated and, if needed in extreme cases, whether alternative approaches described in Section II.D should be considered to address contagion risks from a debt restructuring. - Agreement with key issues on design and implementation of reprofiling as described in Sections III.A, B, and D; and agreement that changes should not apply to normal access cases while establishing a policy to avoid repeat reprofilings in normal access cases. *Italic: Source — IMF staff paper excerpt on “The Fund’s Lending Framework and Sovereign Debt.”* ### Box 3. Impact of Sovereign Debt Maturity Extensions on Domestic Bank Balance Sheets ### Box 3. Impact of Sovereign Debt Maturity Extensions on Domestic Bank Balance Sheets ### Assessment criteria and methodology - Staff reports and other sources were examined for each case to obtain information on the banking system impact. - The criteria used to assess whether the bond exchange had a material impact on the banking sector were to assess if, as a direct result of the bond exchange, any bank in the country needed either additional provisioning or recapitalization. ### Factors that contributed to financial-stability-friendly maturity extensions - Domestically held debt was excluded from reprofilings in some cases. - Banks mainly held their sovereign assets as held-to-maturity (HTM). - The rating downgrade to ‘SD’ was short-lived (less than two months except Pakistan with 11 months). - Regulatory incentives for banks (e.g., Jamaica or Uruguay) were provided. - Capital and liquidity support mechanisms were established (e.g., Jamaica) or were present (e.g., Cyprus). - Some forbearance was used. ### Case findings - Cyprus (2013) - A few weeks ahead of when its bonds were originally due, Cyprus exchanged them with new bonds in the same amount and with the same terms. - Main reason Cypriot banks did not have to book losses: banks had classified the affected sovereign bonds as HTM and assessed, with the possible tacit consent of the regulator, that there was no impairment event. - This allowed banks to maintain the newly exchanged bonds as HTM and not move them to the Available for Sale (AFS) portfolio with the according fair value measurement (as market prices were well below par). - The temporary SD assessment of the rating agencies did not bind Cypriot banks to book losses because the sovereign did not default on its payments and issued new bonds with the same face value and other terms. - The prior bail-in of bank creditors closed the imminent capital hole of the main Cypriot banks. - Jamaica (2010, 2013) - Overall, the size of both bond exchanges was limited to ensure that the losses incurred would not destabilize the financial system. - In both bond exchanges banks mainly held the involved domestic debt as HTM; as there was no impairment event, they did not take any immediate additional provisioning or capital hit from the debt reprofiling exercise. - Rating agencies ruled Jamaica’s domestic government debt as SD but then upgraded the sovereign following the successful completion of each bond exchange. - A Financial Sector Stability Fund (FSSF), set up to help with any capital and liquidity support for financial institutions, was not tapped. - Pakistan (1999) - The November 1999 restructuring of external sovereign debt had a limited impact on the domestic banking sector. - The restructuring involved a slight nominal increase in principal outstanding for two of the three Eurobonds to roll in unpaid interest and the offered terms were relatively attractive to creditors. - About 30 percent of restructured bonds were held by domestic investors. - One participating domestic bank received a capital injection 6 months after the exchange following a bank audit, though the undercapitalization does not seem to be related to the earlier bond exchange. - The SD rating episode lasted 11 months. - Uruguay (2003) - The overall immediate direct impact on the domestic banking system from the domestic and external bond exchange in 2003 was small. - More than 50 percent of the bonds were held by domestic creditors, mostly retail investors. - Domestic bank holdings of government bonds were relatively low, at less than 5 percent of total bank assets and mostly held as HTM. - The fact that domestic banks were mostly holding the sovereign debt as HTM did not matter since the bank supervisor provided strong regulatory incentives for banks to participate in the exchange. ### Summary conclusions - The examined past maturity extensions (Cyprus, Jamaica, Pakistan, and Uruguay) did not have destabilizing effects on the banking system under the conditions observed. - Key enabling conditions included HTM classification of sovereign holdings, limited size of exchanges, short-lived SD ratings (with the exception of Pakistan), regulatory incentives, and available capital/liquidity support mechanisms or prior resolution actions. - Under these circumstances, reprofilings did not force immediate additional provisioning or recapitalization of banks as a direct consequence of the bond exchanges. *Source: Box 3. Impact of Sovereign Debt Maturity Extensions on Domestic Bank Balance Sheets (from the provided IMF content).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_052214.pdf_