Public Information Notice: IMF Board Discusses Possible Features of a New Sovereign Debt Restructuring Mechanism
September 24, 2002

Public Information Notice: IMF Board Holds Informal Seminar on Sovereign Debt Restructuring
April 1, 2002

More Information on Sovereign Debt Restructuring

The IMF and the Private Sector—A Factsheet

Statement on Sovereign Debt Restructuring Mechanism—Further Considerations
By Anne O. Krueger, First Deputy Managing Director, IMF
IMF Executive Board Meeting
Wednesday, September 4, 2002
Washington, D.C.

1. The paper before Directors today is a step in responding to a request from the IMFC that the Fund continue to examine the legal, institutional, and procedural aspects of the two proposals to improve the process of sovereign debt restructuring.1 Previously we have discussed papers on collective action clauses.2 I hope that today we can carry forward the discussion of the SDRM, by focusing on two specific issues: the scope of debt to be covered by the mechanism and the dispute of resolution procedures. I am looking forward to hearing the views of Executive Directors.

2. It is generally accepted that in cases in which a member has an unsustainable debt burden there is a need to reach agreement with creditors on a restructuring that, taken with appropriate policies, provides a basis for a return to medium-term sustainability. There is also a growing recognition that there is a need to improve existing debt restructuring mechanisms. The SDRM seeks to provide such an improved mechanism, by establishing incentives for a debtor and its creditors to move expeditiously toward a restructuring that both allows debts to be aligned with payment capacity and preserves asset values. It is intended to provide a mechanism for the resolution of collective action difficulties associated with agreements on restructurings, as well as temporary limitations of the enforcement of creditors' claims and the provision of priority financing.

3. As we develop our approach to the SDRM, we have continued to benefit from constructive discussions with Executive Directors, and a wide range of interlocutors drawn from the official community, academia, and the private sector. The perspectives of country authorities, participants in capital markets, as well as those versed in the experience of debt workouts have helped us refine our understanding of the issues, and approaches to the design of the mechanism. Inevitably, as we move beyond the general framework, the issues become complex, and on occasion, somewhat technical.

4. Our earlier discussions examined a framework for the mechanism in which key decisions—the approval and extension of the stay on litigation; provision of priority financing on a senior basis; and the approval of restructuring proposals—would be approved by an affirmative vote of a qualified majority of creditors. As we go beyond this general principle, questions arise as to the scope of debt that would need to be covered by the SDRM in order for it to be effective in facilitating an orderly restructuring, as well as achieving key policy objectives, relating, for example, to the continued operation of the domestic banking system.

5. Indeed, when considering the scope of debt to be covered under the SDRM, it is necessary to balance a number of different objectives. On the one hand, the mechanism must be sufficiently comprehensive to facilitate an orderly restructuring of debt to a sustainable level, while paying due regard to addressing the intercreditor equity concerns in order to mobilize broad support. Moreover, in order to address collective action problems effectively, the voting provisions must provide for sufficient aggregation across instruments. On the other hand, the mechanism must pay due regard to the fact that not all creditors are similarly situated and that, therefore, equity may require differentiation among creditors. In addition, differentiation may be necessary from an economic policy perspective, particularly where a significant amount of debt is held by the domestic banking system.

6. The paper identifies two different techniques that can be used to balance these objectives with respect to different categories of debt.

  • The first would involve including a category of debt under the SDRM as a separate class. Support by a qualified majority of creditors in each class would be required to approve the restructuring terms offered to all classes. While votes would be aggregated across instruments (thereby greatly reducing the leverage of holdouts), there would be no aggregation of votes across classes. However, since all classes would be required to approve the overall restructuring, each creditor class would have an effective veto over the overall terms of the restructuring. Finally, while all creditors within the same class would need to receive the same restructuring terms, treatment of creditors across classes could be different.
  • The second technique would be to exclude a certain category of debt from the SDRM on the understanding, however, that, this debt could be restructured through pressure exercised by creditors whose claims are covered by the SDRM. As a condition for voting in favor of a restructuring of their claims under the SDRM, these creditors would insist that any debt that is not covered by the mechanism be restructured in a manner that addresses their concerns regarding intercreditor equity.

7. With respect to the treatment of domestic debt, the paper addresses two different questions. First, are there circumstances where domestic debt will need to be restructured in order to achieve medium-term sustainability? Second, if such circumstances do arise, how can the SDRM be designed so as to ensure that this debt is restructured in a manner that pays due regard to its special features?

8. On the first question, it seems likely that in most cases, it will be necessary to include domestic debt, both to produce a reduction in the debt and debt-service burden of a sufficient magnitude to achieve sustainability, and in order to achieve adequate intercreditor equity to garner broad creditor support. We have listened carefully to those who have argued that the behavior of resident investors, or the characteristics of local currency-denominated instruments, could justify some differentiation in the treatment of certain claims. With the progressive increase in capital mobility as members become more integrated into global capital markets, however, and with limitations on the availability of domestic financing within the framework of a monetary program, the scope for any such differentiation appears to be limited, and likely to diminish over time. Nevertheless, this would obviously need to be examined on a case-by-case basis. Of course this does not distract from the need to consider how best to ensure the continued functioning of at least a core of the domestic banking system and the operation of the payment and settlement system.

9. With respect to the second question, the paper identifies alternative approaches. Under one approach, domestic debt (i.e., debt governed by domestic law) would be included within the SDRM as a separate class. Under the alternative approach, although this debt would be excluded from the coverage of the SDRM, it could be restructured—where necessary—through the exertion of pressure by creditors holding claims that are subject to the mechanism. As noted earlier, such creditors could make a restructuring of domestic debt a condition for their support for a restructuring of their own claims under the SDRM. Although each approach has its own advantages and disadvantages, my own view is that the latter approach has more promise. Among other things, it may make it easier for member countries to adopt the SDRM.

10. The paper also provides a preliminary discussion of possible approaches to the treatment of the claims of official bilateral creditors. Such claims are now restructured under the auspices of the Paris Club, which has demonstrated over more than four decades its effectiveness in providing early support for members' adjustment programs, and its capacity to respond flexibly to changing circumstances. Against this background, one possible approach would be to exclude the claims of official bilateral creditors from the SDRM, while considering possible ways to strengthen the coordination between the Paris Club and private creditors. A second possible approach that warrants careful consideration would bring the claims of official bilateral creditors under the SDRM, but as a separate creditor class. Such an approach would need to be implemented flexibly, and would require some adaptation of the Club's practices so as to allow it, on the one hand, to continue to provide an early signal of support for a member's adjustment program, and on the other, to delay agreement on the final terms of a restructuring until these can be coordinated with the restructuring of the claims of private creditors. Although each approach has its own advantages and disadvantages, I find the arguments evenly balanced, though I have heard the views of a wide range of private sector participants who generally favor bringing the Paris Club debt under the SDRM.

11. Finally, the paper elaborates a number of features of the dispute resolution forum that could be established under the SDRM. While we envisage that the scope of the authority of this forum would be relatively limited, the Sovereign Debt Dispute Resolution Forum (SDDRF) would play a critical role in safeguarding the integrity of the voting process. In terms of its structure, the manner in which the SDDRF is established should be guided by four principles: independence, competence, diversity, and impartiality. Although I recognize that there are different ways to implement these principles, I believe that the overall framework proposed in the paper establishes a useful basis for our discussion. In general, I am confident that it is possible to establish a dispute resolution forum that is independent—and is perceived as being independent—from the Fund's management and Executive Board.

1 Communiqué of the IMFC, Washington DC, April 20, 2002.
2 Public Information Notice: IMF Board Discusses Collective Action Clauses in Sovereign Bond Contracts , July 26, 2002.