September 24, 2002
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On September 4, 2002, the Executive Board of the International Monetary Fund (IMF) gave further consideration to the good faith criterion under the Fund's lending into arrears policy.
Background
Conceived in the late 1980s as an element of resolving the debt crisis, the scope of the Fund's policy concerning lending into sovereign external payments arrears to private creditors has undergone a number of modifications to keep pace with developments in capital flows to emerging market countries. In 1998, the scope of the policy was broadened from commercial bank credits to encompass arrears on international sovereign bonds and other nonbank private credits. In 1999, in view of the expanding creditor base and the diversity of its interest raising concerns about the readiness of creditors to reach agreement promptly with sovereign debtors, the policy was again modified. The 1999 policy specified that Fund lending into sovereign arrears to external private creditors can be granted in circumstances in which: (i) prompt Fund support is considered essential for the 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 creditors.
Through this process of adaptation, the Fund sought to uphold the policy's main objectives of helping limit the scale of economic dislocation and destruction of asset values, while providing adequate safeguards for the use of Fund's resources. The conditions for Fund lending were intended to send a strong signal to the international financial community regarding the strength of the member's policies, and the need for the member and its creditors to make rapid progress toward a collaborative agreement on a debt restructuring that would provide adequate financing during the program period and pave the way for a return to external sustainability.
Over the past few years, experience with the restructuring of international sovereign bonds, although limited, suggests that the process was in some cases protracted and involved considerable uncertainty. Concerns have arisen about the actions of the two sides pending a restructuring, and the modalities of the debtor-creditors dialogue. While the effects of the uncertainty regarding the restructuring process is difficult to quantify, greater clarity on the procedural aspects of restructuring could serve the interest of debtors and creditors alike.
In this context, the Executive Board discussion of the paper prepared by the staff1 aimed at clarifying what members should reasonably be expected to do in terms of a timely and substantive engagement with their private external creditors in the context of the lending into arrears policy. The revised policy seeks to balance the need to promote an effective dialogue and the need to retain sufficient flexibility in providing timely assistance in individual cases. Because the specific circumstances of individual cases may differ widely, the modalities of a dialogue consistent with the policy may also vary. In some cases informal means of dialogue may be appropriate. In other cases debtor's interests may be best served by working closely with a representative committee of creditors. The paper proposes a framework of general principles and procedures to guide the dialogue. In all cases a member would be expected to engage in a dialogue to provide relevant nonconfidential information, and to provide creditors with an early opportunity to provide input to the design of restructurings. In addition, in cases in which the debt situation is judged to be complex, if creditors have formed a committee within a reasonable period which is sufficiently representative, there would be an expectation that the member would make good faith efforts to negotiate with the committee in accordance with principles developed in the paper, though the unique characteristics of each case would be considered.
Executive Board Assessment
Directors agreed that the Fund's policy on lending into sovereign arrears to private creditors continues to provide a useful tool enabling the Fund to support a member's adjustment efforts before it has reached agreement with its private creditors on a debt restructuring. The pillars of this policy are first, that the timely support of the member's adjustment program is considered essential to help limit the scale of economic dislocation and preserve the economic value of investors' claims; and second, that the debtor engages its creditors in an early and constructive dialogue to help secure a reasonably timely and orderly agreement that would help the country regain external viability.
Directors welcomed the opportunity to review the application of the criterion requiring a member to make good faith efforts to reach a collaborative agreement with its creditors, in light of the experience with bond restructurings since the introduction of the "good faith" criterion in 1999. They observed that this experience, although limited, suggests that notwithstanding the ability of debtors to reach restructuring agreements with their creditors, the restructuring processes have in some cases been protracted, reflecting the complexity of each individual case, as well as different perspectives and concerns among debtors and creditors.Against this backdrop, Directors agreed that greater clarity about the good faith dialogue between a debtor and its creditors during the restructuring process could help provide better guidance about the application of the lending into arrears policy and, more generally, promote a better framework for the engagement of debtors and creditors in the restructuring of sovereign debt. Greater clarity concerning the framework for possible debt restructuring would strengthen the capacity of investors to assess recovery values under alternative scenarios, thereby facilitating the pricing of risk and improving the functioning of the capital markets. At the same time, however, Directors stressed the need for continued flexibility in applying the "good faith" criterion to accommodate the characteristics of each specific case; to avoid putting debtors at a disadvantage in the negotiations with creditors; and to avoid prolonged negotiations that could hamper the ability of the Fund to provide timely assistance. Indeed, any clarification of the "good faith" criterion should serve primarily to support the difficult judgments that will continue to have to be made in each case, and should be made operational in a manner that does not impair market discipline.
Directors considered that the following principles would strike an appropriate balance between clarity and flexibility in guiding the dialogue between debtors and their private external creditors.
· an explanation of the economic problems and financial circumstances that justify a debt restructuring;
· a briefing on the broad outlines of a viable economic program to address the underlying problems and its implications on the broad financial parameters shaping the envelope of resources available for restructured claims; and
· the provision of a comprehensive picture of the proposed treatment of all claims on the sovereign, including those of official bilateral creditors, and the elaboration of the basis on which the debt restructuring would restore medium-term sustainability, bearing in mind that not all categories of claims may need to be restructured.
In discussing the various approaches that would best clarify the content of a member's good faith efforts in the context of the lending into arrears policy, Directors emphasized that the modalities guiding the debtor's dialogue with its creditors will need to be tailored to the specific features of each individual case. Most Directors considered that the third approach suggested in the staff paper for refining the good faith criterion provides an appropriate basis for the implementation of the Fund's policy, while retaining sufficient flexibility to address the diversity of individual situations. Although, as a general premise, the form of the dialogue would be left to the debtor and its creditors, under this approach a member in arrears would be expected to initiate a dialogue with its creditors prior to agreeing on a Fund-supported program consistent with the principles discussed above. In cases in which an organized negotiating framework is warranted by the complexity of the case and by the fact that creditors have been able to form a representative committee on a timely basis, there would be an expectation that the member would enter into good faith negotiations with this committee, though the unique characteristics of each case would also be considered. This formal negotiating framework would include, inter alia, the sharing of confidential information needed to enable creditors to make informed decisions on the terms of a restructuring (subject to adequate safeguards), and the agreement to a standstill on litigation during the restructuring process by creditors represented in the committee. By the same token, in less complex cases, where creditors have not organized a representative committee within a reasonable period, or where for other reasons a formal negotiation framework would not be effective, the member would be expected to engage creditors through a less structured dialogue. Directors stressed that, in going forward with the suggested approach, it would be crucial to strike the appropriate balance between the need to promote effective communication between a debtor and its creditors, and the need to retain flexibility to address the diversity of individual country circumstances.
Directors discussed a variety of factors that would need to be considered in making the proposed framework operational. They emphasized that in assessing whether the member is making good faith efforts to negotiate, judgments would continue to be required in a number of important areas. These include a consideration of the complexity of the restructuring case, the extent to which a creditor committee is sufficiently representative, and whether a reasonable period has elapsed to allow for the formation of a representative committee. Directors viewed the considerations laid out in the staff paper as useful inputs for helping to make such judgments, which would need to be made flexibly. They also noted that to the extent that negotiations become stalled because creditors are requesting terms that are inconsistent with the adjustment and financing parameters that have been established under a Fund-supported program, the Fund should retain the flexibility to continue to support members notwithstanding the lack of progress in negotiations with creditors. In this connection, it was stressed that decisions on an adequate macroeconomic framework that could form the basis for the Fund's lending into arrears will remain in the sole purview of the Fund.
Directors recognized that there may be circumstances where, following a default, the debtor enters into good faith discussions with creditors prior to the approval of a Fund arrangement. In these circumstances, creditors are likely to express views as to the appropriate dimensions of the program's adjustment and financing parameters. While such input would be welcome, Directors emphasized that it would be inappropriate for private creditors to be given a veto over the design of the financing plan or the design of the adjustment program.
All purchases made while a member has outstanding arrears to private creditors will continue to be subject to financing reviews, which will provide an opportunity for the Fund to monitor relations between a debtor and its creditors, and for the Board to be kept informed about developments in this area at an early stage. Going forward, a number of Directors also underscored the importance of strengthening debtor-creditor dialogue in good times, as this will provide a good base for advancing the required negotiation framework in times of stress.
