Press Release: IMF Executive Board Discusses Strengthening the Contractual Framework in Sovereign Debt Restructuring

IMF News, October 6, 2014

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Published: October 6, 2014

Background and context

Press Release No.14/459; published October 6, 2014.
On October 1, 2014, the Executive Board of the International Monetary Fund (IMF) discussed the staff paper “Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring.”
The staff paper follows up on Executive Board guidance from May 2013 arising from an earlier staff paper: “Sovereign Debt Restructurings–Recent Developments and Implications for the Fund’s Legal and Policy Framework.”
The May 2013 guidance asked staff to present options for reforming the Fund’s policy framework in four areas:
- (i) the relationship between the Fund’s lending framework and sovereign debt vulnerabilities;
- (ii) the effectiveness of the contractual, market-based approach to debt restructuring in overcoming collective action problems;
- (iii) the framework for official sector involvement; and
- (iv) the lending-into-arrears policy.

Proposed contractual reforms (staff paper)

The staff paper focuses on contractual reforms designed to address collective action problems to achieve orderly sovereign debt restructurings.
These proposed reforms reflect extensive consultation over an 18-month period with issuers and market participants, including with the International Capital Market Association.
Main proposed contractual changes:
- Modify the pari passu clause in international sovereign bonds to make clear that it does not require the issuer to pay creditors on an equal or ratable basis.
- Include an enhanced collective action clause (CAC) that includes a more robust “aggregation” feature to address collective action problems more effectively.
- Consider the Fund’s role in promoting the use of these modified provisions in future issuances of international sovereign bonds, while noting transitional risks from the existing stock of bonds that do not contain such modified provisions.

Executive Board assessment and key findings

Directors welcomed discussion of contractual framework reforms as part of the broader sovereign debt restructuring work stream.
Directors noted the objectives of the work streams:
- facilitating timely and orderly sovereign debt restructurings, where restructurings are deemed necessary; and
- reducing the overall costs to the system.
Directors recognized that recent developments, including the Argentine litigation in the U.S. courts, underscore the importance of strengthening the contractual framework.
On the Fund’s role:
- The Fund’s primary role will be to facilitate agreement on the design of contractual provisions and promote their use in an advisory capacity, since design and use decisions rest with sovereign issuers and their creditors.

Pari passu clause: assessment and recommendation

Directors acknowledged that recent New York court decisions with respect to Argentina may exacerbate collective action problems, while noting uncertainty about the extent of the impact.
Directors welcomed recent modifications of pari passu clauses in certain sovereign bond issuances that explicitly exclude an obligation to effect ratable payments.
Directors supported the widespread use of these types of modified pari passu clauses in new international sovereign bonds to enhance legal certainty and consistency across jurisdictions.

Collective Action Clause (CAC): assessment and design guidance

Directors noted broad stakeholder support for CACs with robust aggregation features.
Specific design guidance agreed by Directors:
- Consider a “single-limb” voting procedure that enables bonds to be restructured on the basis of a single vote across all affected instruments as an effective tool against holdouts.
- As a safeguard, require that all affected bondholders be offered the same instrument or an identical menu of instruments where a single-limb procedure is used.
- Include a voting threshold of 75 percent of the aggregated outstanding principal of all affected series for aggregated voting.
Directors emphasized flexibility to allow differentiation among creditors where appropriate and supported a single CAC with a menu of voting procedures, including:
- (a) a single-limb voting procedure with the possibility for “sub-aggregation” (ability to conduct separate votes for different groups of bond issuances);
- (b) a two-limb aggregated voting procedure; and
- (c) a series-by-series voting procedure.
Other CAC design features endorsed by Directors:
- CACs should accommodate a broad range of debt instruments, including bonds denominated in different currencies and governed by different foreign laws.
- Priority should be given to promoting inclusion in foreign law-governed bonds, given that these bonds give potential holdouts the greatest legal leverage.
- For euro area sovereigns, Directors considered the existing requirement (a CAC that allows for either a series-by-series voting procedure or a two-limb voting procedure) appropriate, taking into account that euro area issuances are, in most cases, governed by domestic law.
- CACs should include robust disenfranchisement provisions consistent with those generally found in international sovereign bonds to address potential manipulation of the voting process.
- Documentation should be transparent about both the design of the CAC and the scope of debt it will cover.
- If requested by creditors, the CAC should include information covenants consistent with Fund policy.

Promoting contractual reform and transition risks

Directors supported an active role for the Fund in promoting the inclusion of enhanced contractual provisions in new international sovereign bond issuances and endorsed the three-pronged approach outlined in the staff paper.
Directors noted that the significant stock of outstanding international sovereign bonds will take time to mature, posing a risk to orderly restructurings; the magnitude of such risk remains uncertain.
Directors encouraged staff to engage in further discussions with stakeholders on ways to minimize transition risks.
Directors requested periodic progress reports on the status of inclusion of the proposed contractual provisions in international sovereign bonds.

IMF Press Release No.14/459, October 6, 2014 — Executive Board discussion of staff paper “Strengthening the Contractual Framework to Address Collective Action Problems in Sovereign Debt Restructuring.”