Acting Collectively: A Better Way to Restructure Government Debt

IMF Blog, November 24, 2014

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Acting Collectively: A Better Way to Restructure Government Debt

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Bibliographic details

• Authors: Sean Hagan
• Published: November 24, 2014

Context and motivation

• Author: Sean Hagan
• Date: November 24, 2014
• Theme: Sovereign debt restructuring should be prompt, predictable, and orderly to reduce costs to the debtor, creditors, and the financial system.
• Background observations:
  • The global financial crisis led to a new wave of sovereign debt crises, reinvigorating discussion on the sovereign debt restructuring framework.
  • Experience with Greece’s 2012 restructuring and ongoing litigation involving Argentina highlight remaining vulnerabilities.
  • An 18-month process of consultation and collaboration among the IMF, sovereign issuers, market participants, and official-sector representatives produced the endorsed reforms. The International Capital Markets Association (ICMA) and U.S. Treasury were key counterparts.

What the reforms achieve

• Objectives:
  • Minimize the risk that a restructuring supported by a large majority of creditors could be obstructed by a small group of creditors.
  • Reduce the cost of crisis resolution through market-based solutions and improvements in the IMF’s lending and engagement processes during restructurings.
• Key contractual changes:
  • Pari passu clause:
  • Revision explicitly rules out the New York courts’ interpretation requiring equal payment to all bondholders and limits the clause to a protection of legal ranking.
  • Motivated by Argentina litigation where a minority paralyzed a restructuring approved by 93% of bondholders.
  • Collective action clauses (CACs):
  • Problem with older CACs: most require a majority of each bond series to vote in favor, enabling holdouts to acquire a blocking stake (normally, 25% of that series) at relatively low cost and prevent restructuring of that series.
  • Example: In the 2012 Greek bond restructuring, holdouts were eventually paid out in full—to the tune of €6.5 billion.
  • New approach: aggregated voting basis allowing a restructuring to be passed by a 75% majority across all bond series under the most robust form.
  • The 75% supermajority requirement still preserves creditor support as necessary; it prevents an obstructive minority from blocking the process.
  • ICMA adopted the single voting procedure in their new standard bond terms, with creditor support being a key reason.
• Safeguards and flexibility:
  • All creditors must be offered the same restructuring terms, or a menu of terms.
  • Protections against sovereigns influencing votes (for example, by buying up a large share of the bonds).
  • Issuers and creditors retain flexibility to use other voting procedures where appropriate (e.g., to offer different terms).

Implementation and early testing

• Early adopters:
  • Mexico, Vietnam, and Kazakhstan have issued bonds incorporating the new clauses.
  • Observation: Use of the new clauses did not have any meaningful price impact.
• IMF stance:
  • The IMF is endorsing critical features of these clauses, not specific language, recognizing that features can be drafted differently across jurisdictions.
  • The IMF will actively encourage and monitor wider adoption by sovereign issuers.

Limitations, transitional risks, and policy implications

• Legacy bonds:
  • There remains an outstanding stock of sovereign bonds worth a significant $900 billion that do not contain the new clauses, with a large portion not maturing for another 10 years.
  • The risk posed by these legacy bonds during the transition will depend on how New York court decisions are interpreted in future litigation.
  • Possible mitigation: issuers swapping old bond contracts for new ones before maturity.
• Broader policy emphasis:
  • Countries must maintain sound policies to prevent public debt burdens from becoming unsustainable.
  • These contractual reforms are incremental relative to other reforms under consideration (including at the United Nations) but represent meaningful progress achieved through private–official sector collaboration.
  • The reforms make it easier to carry out sovereign debt restructuring when needed while preserving protections for creditor rights.

Source: Acting Collectively: A Better Way to Restructure Government Debt, Sean Hagan, November 24, 2014 (IMF blog)

References

• an IMF paper