Bankruptcy Regime at International Level — Independent of IMF — Could Handle Debt Crises Fairly, Efficiently, Keynote Speaker Tells Economic and Social Council
Bankruptcy Regime at International Level — Independent of IMF — Could Handle Debt Crises Fairly, Efficiently, Keynote Speaker Tells Economic and Social Council
|Department of Public Information • News and Media Division • New York|
Economic and Social Council
8th & 9th Meetings (AM & PM)
Bankruptcy Regime at International Level — Independent of IMF — Could Handle Debt
Crises Fairly, Efficiently, Keynote Speaker Tells Economic and Social Council
Holds Special Meeting on External Debt Sustainability and Development;
Panels: History of Debt Crises; Work on Restructuring Mechanisms; Architecture
Market solutions alone were not enough to handle the problems caused by excessive sovereign debt, a Nobel Prize-winning economist told delegates at a special meeting of the Economic and Social Council today.
During his keynote address to the Council — which was meeting to examine external debt sustainability and development following yesterday’s annual meeting with international financial and trade institutions — Joseph Stiglitz said the rules surrounding domestic bankruptcy existed specifically because the market could not handle the problem of high debt and that the same was true internationally. Efficiency and equity demanded that sovereigns be granted the same right to a “fresh start” that was afforded businesses and this was particularly important given the “enormous waste of resources” caused by high sovereign debt.
No legal framework was currently in existence, despite the fact that better institutions would make both creditors and debtors better off. He proposed a world bankruptcy organization, independent of the International Monetary Fund (IMF), which he believed to be too closely linked to creditors, and described the process by which it would seek to work out and resolve sovereign debt issues efficiently and fairly. The risks, delays and the magnitude of crises would all be reduced by a regime that resolved problems quicker and more certainly.
He stressed the need to be fair to borrowers, who were usually blamed for debt distress despite the fact that lenders were at least equally responsible. Every contract had two sides, both of which were voluntary, meaning that lenders — usually more financially sophisticated than borrowers with better risk assessment capabilities — were providing capital despite high risks and were, therefore, guilty of “predatory lending”.
In a panel discussion that followed on “the architecture for debt restructuring”, Sergio Chodos, Alternative Executive Director, International Monetary Fund, emphasized that market solutions did not work in large part because the vast array of stakeholder interests were not aligned. “There’s no logical incentive to align the incentives,” he said. A hedge fund that bought in the secondary market, for example, was not a lender. It was a claimant, but it did not behave like a primary buyer or a direct lender, or even a vulture fund that purchased after default — and then pushed for default. The main problem had been one of incentives.
Hans Humes of Greylock Capital Management provided a view of the situation from the perspective of a creditor. He said the big problem was getting people to the negotiating table. In the case of Greece, it was the private sector that had noted it was heading towards default because of its unsustainable debt-to-GDP (gross domestic product) ratio. Creditors paid attention to the risks of sovereign debt defaults and acted pre-emptively, he said, as in the case of Cyprus recently.
Lee Buchheit, a Partner at Cleary Gottlieb Steen and Hamilton, addressed the issue of holdouts, saying they represented both a financial and emotional risk. When designing a sovereign debt programme, the architect assumed that the creditor would lend to the debtor the total funds needed, which was often not the case. The sovereign debtor imposed bitter austerity measures, while the creditor wrapped itself around the legal sanctity, demanding repayment.
Other presentations on the issue were made by Deborah Nache-Zandstra, Partner, Sovereign Debt Restructuring Group, Clifford Chance, London; and James Haley, Executive Director, Inter-American Development Bank.
In the morning, delegates heard presentations on “Lessons learned from the history of debt crises” by Jeffrey Lewis, Director, Economic Policy, Debt and Trade Department, World Bank; and Christoph Paulus, Professor, Humboldt University, Berlin. They were followed by two more presentations on “Ongoing work on sovereign debt restructuring and debt resolution mechanisms” delivered by Yuefen Li, Head of the Debt and Development Branch, United Nations Conference on Trade and Development (UNCTAD), and Benu Schneider, Senior Economic Affairs Officer, Financing for Development Office, United Nations Department of Economic and Social Affairs.
Prior to the presentations in the morning, opening remarks were given by Economic and Social Council President Néstor Osorio of Colombia, who stressed the work being done by UNCTAD and the Department of Economic and Social Affairs to address debt problems and the architecture for resolving them, adding that the debate on sovereign debt restructuring would have a major impact on financing for sustainable development and on the post-2015 development agenda. The international community needed to “promote responsible borrowing and lending, along with improved debt management”, he said.
Also delivering opening remarks were Dr. Supachai Panitchpakdi, Secretary-General of the United Nations Conference on Trade and Development, who said thoughtful deliberation and coordinated action were needed to resolve the debt crisis. The ad hoc collection of arrangements currently in place needed to be improved and expanded beyond financial approaches, he added, noting that market-based approaches had not been successful.
Shamshad Akhtar, Assistant Secretary-General for Economic Development in the United Nations Department of Economic and Social Affairs, also speaking at the morning session, hoped the meeting could push forward thinking on debt sustainability and development. Efforts were needed to reduce the time periods between distress and default and between default and restructuring, both of which were currently too long. She explained the failure of market-based or voluntary solutions by saying that creditors had no incentive to give ground, especially when debtors were in weak negotiating positions. Rules in debt restructuring could allow “faster and more equitable burden distribution, ensuring a return to debt sustainability and sustainable and inclusive growth”.
Josaia Voreqe Bainimarama, Prime Minister of Fiji, also addressed the Council during the morning session, speaking on behalf of the “Group of 77” Developing Countries and China.
The Economic and Social Council met this morning to hold a special one-day meeting on “External debt sustainability and development: Lessons learned from debt crises and ongoing work on sovereign debt restructuring and debt resolution mechanisms”. The meeting was recommended by General Assembly resolution A/RES/67/198.
NÉSTOR OSORIO (Colombia), Economic and Social Council President, said that the United Nations Department of Economic and Social Affairs and the United Nations Conference on Trade and Development (UNCTAD) were playing an important role in engaging experts and stakeholders to garner ideas and proposals for enhancing the architecture for resolving debt problems. He hoped that the Economic and Social Council meeting could build on a General Assembly event that discussed debt in October. He hoped the meeting would help “build momentum to find solutions for countries that face problems of debt overhang and debt servicing”.
He pointed out that debt defaults were nothing new, and neither were attempts to find solutions. The Heavily Indebted Poor Countries (HIPC) Debt Initiative and the Multilateral Debt Relief Initiative (MDRI) had contributed greatly to addressing debt overhang in many low-income countries. Growth and good policy had helped to improve debt indicators in many developing countries, but he added that “aggregate indicators” masked those countries’ debt sustainability problems. Currently, the issue of sovereign debt was at the forefront of policy discussions, because of difficulties faced by European countries. The fact that wealthier countries were facing debt problems marked the difference between the current crisis and previous periods in which the world community dealt with debt problems. The problems faced by euro zone countries also had far-reaching consequences across the world, making resolution of the problems a global concern.
The debate on sovereign debt restructuring would have a major impact on financing for sustainable development and on the post-2015 development agenda, he said. Countries with debt distress were less able to attract financing for sustainable development and countries with debt overhangs often spent a large proportion of public resources on debt servicing, rather than funding sustainable development. The international community, therefore, needed to “promote responsible borrowing and lending, along with improved debt management”. Countries and the entire global economy were at risk of destabilization, because of “irresponsible actions in lending and borrowing”. It was Member States who were responsible for tackling the issue and determining the scope and pace of work to deal with the problem.
SUPACHAI PANITCHPAKDI, Secretary-General of the United Nations Conference on Trade and Development (UNCTAD), said debt crisis resolution called for thoughtful deliberation and coordinated action, adding that such events could have numerous origins that might not be fiscal in nature. There was currently an ad hoc collection of arrangements in place, composed of “collective action” clauses, Paris club treatments for official debts, Brady Bonds and efforts including the HIPC Debt Initiative, a patchwork that hindered countries’ ability to act quickly. Debt deflation problems would take a long time to unwind. “We cannot deal with financial issues through financial means alone.”
Fiscal or austerity policies alone would not prevent external debt from expanding beyond gross domestic product (GDP), he said. The coming years would provide a good “laboratory” for examining how economic issues could solve such problems. He urged delegates not to be misled by the aggregate picture for developing countries, which showed improved external debt-to-GDP ratios, at below 20 per cent. For advanced countries, that ratio had gone beyond 50 per cent of GDP. However, there were still countries coping with a rising share of external debt to GDP. Developing countries were extending net borrowings.
“If you go overboard with austerity measures, that might reduce growth without reducing debt,” he said. Turning to lessons for tackling financial reforms, he said the need for debt resolution tended to be underestimated. Piecemeal solutions had been put forward in hopes that the banking system — which had not cleaned up its balance sheets — would resume lending. Second, countries had waited too long for restructuring efforts to be executed, which created economic uncertainties that fostered slower global growth. He urged defining a “tipping point” that countries could use as a warning signal that the situation needed to change. For big “locomotives”, ongoing adjustments to debt relief amounted to “kicking the can down the road”, which could be devastating in the long run. Solutions should include cleaning up the banks in a timely manner. Also, market-based approaches, like lengthy debt negotiations, had not led to debt sustainability.
SHAMSHAD AKHTAR, Assistant Secretary-General for Economic Development, United Nations Department of Economic and Social Affairs, hoped the meeting could act as a “step forward” on debt sustainability and development. The economic crisis and debt distress in Europe revealed the deep vulnerabilities at the core of the international financial architecture. The time period between distress and default had been too long. In Europe, avoiding default had been a priority, partly because of the high economic and political costs associated. There were incentives to “gamble for resurrection” and costs grew when the bet eventually did not come off. Additional debts were incurred and needed repayment, and prolonged uncertainty harmed the economy. A framework for sovereign debt restructuring could provide incentives to avoid additional costs and could speed up the move from default to restructuring, which also tended to be too long. Market-based or voluntary solutions had generally failed, because creditors had no incentive to give ground and debtors were in such weak negotiating positions, possibly resulting in them settling for less relief than truly needed. Rules in debt restructuring could allow “faster and more equitable burden distribution, ensuring a return to debt sustainability and sustainable and inclusive growth”.
She believed that the lack of “bankruptcy” in the sovereign debt market affected both the cost and extent of borrowing, creating a highly inefficient market for both creditors and debtors. The primacy of “sovereignty” in the international order meant judgements against sovereigns were not necessarily enforceable. Holdouts, such as in the case of Argentina, were fairly rare, but showed the legal limits of debt exchanges under the current system. A rules-based system would benefit both sovereigns and creditors, she argued, reducing risks and eliminating the incentives for vulture funds to gamble in sovereign debt markets. Other benefits of a debt restructuring mechanism included improved coordination and fair representation of the debtor and all dispersed creditors, establishment of priority rules among creditors, and provision of an early response system, which would allow space to find a solution and protect against litigation.
She stressed the importance of early engagement of debtors and creditors to frankly address unsustainable situations in a timely manner. There was ample reason to support the establishment of “a practical and fair architecture for sovereign debt restructuring,” and the Department of Economic and Social Affairs had held meetings to garner ideas on what could be done ex-ante to provide a more stable, fair, and efficient system and identify options. She welcomed the recent indication by the International Monetary Fund (IMF) Managing Director that the IMF was working on debt sustainability and sovereign debt restructuring, saying it augured well for evolution towards an acceptable international approach to sovereign debt resolution.
JOSAIA VOREQE BAINIMARAMA, Prime Minister of Fiji, on behalf of the “Group of 77” Developing Countries and China, attached great importance to the role of multilateral institutions in helping developing countries achieve and maintain debt sustainability. The total external debt for developing countries had hit $4.5 trillion from 2010-2011 and new mechanisms were needed to address high debt sustainability. The global economic and financial crisis had prevented many developing countries from enacting fiscal measures to mitigate its impacts, which highlighted systemic fragilities. Their recovery had been threatened by turbulence in global financial markets. He was concerned about financial sustainability risks in developed countries, calling for measures to address sovereign risks.
He also voiced concern about the methods used by credit ratings agencies, as they did not always reflect the solvency of the debtor. Those agencies also lacked transparency and objective assessment criteria. Standard-setting bodies should reduce their reliance on them and develop objective criteria for assessing credit risks. Further, external shocks had impacted countries’ abilities to service their debt obligations. No path to growth could be travelled with debt overhang. Debt restructuring should address countries’ “real repayment” capacity.
Moreover, he expressed concern at “vulture fund litigations”, double restructuring processes and debt sustainability itself, underscoring that sovereign debt management was a crucial issue for developing countries. Vulture funds posed a risk for all future debt restructuring processes and they must not be allowed to paralyse the debt restructuring of developing countries. He argued for a fair, human-centred and development-oriented mechanism to help ensure Governments fulfilled their peoples’ aspirations. He also urged the adoption of legislation, in line with the Guiding Principles on Foreign Debt and Human Rights, to prevent such funds from such abuse, as well as establishment of a system for debt arbitration.
For the first panel, the Council first heard presentations on “Lessons learned from the history of debt crises”.
JEFFREY D. LEWIS, Director, Economic Policy, Debt and Trade Department, World Bank, said the world had learned from debt crises but had perhaps not yet learned all lessons. He praised efforts to tackle the debt crisis in low-income countries during the 1990s, saying a comprehensive international agreement had been struck for a comprehensive debt relief mechanism that tackled all debts, including multilateral debts. The agreements to follow — the HIPC Debt Initiative and Multilateral Debt Relief Initiatives — had largely been implemented, with 35 of the 39 countries involved completing the processes and reducing their external debt stocks by an average of 90 per cent. He praised the HIPC Initiative for its flexibility in application, stating that it recognized the different circumstances faced by different countries. Commercial debt had also been a big problem and the World Bank’s Debt Reduction Facility had bought back $10 billion of the debts of 21 Heavily Indebted Poor Countries. It was significant, he stressed, that the issue of commercial debt had been tackled internationally and he pointed to high creditor participation in the scheme and high discount rates on the buybacks. In general, the “severity of debt distress” had dropped, with fewer countries in high risk of distress and more at low risk. There was also some evidence that Heavily Indebted Poor Countries had increased expenditure on poverty reduction as their debt service ratios had decreased.
Challenges remained, he acknowledged, noting that some Heavily Indebted Poor Countries were yet to reach the “decision point”. Other countries faced uncertain futures. The Debt Reduction Facility was still to reach over 20 countries and had at least $11 billion of debt still to buy back. He stressed that the HIPC Debt Initiative was not designed to prevent countries from borrowing, but rather to allow countries to establish conditions to allow normal engagements with capital markets. He was pleased to see borrowing taking place, but stressed that borrowing needed to be pushing investment and development, noting with concern that eight countries had returned a third of the way to where they had been four years before debt relief. Small States faced particular difficulties, accounting for half of the countries facing the highest public debt. Looking ahead, large debt relief initiatives were no longer the answer. Focus should instead fall on addressing the causes of debt distress to prevent crises from spreading. Credible medium-term fiscal and debt management strategies, along with technical assistance and capacity-building, were needed to help countries avoid the conditions that created crises. He called for a focus on longer-term debt sustainability and noted the World Bank’s current focus on supporting debt management, while also referring to the need for better monitoring of country performance and vulnerabilities.
CHRISTOPH PAULUS, Professor, Humboldt University, Berlin, underlined the systemic risks posed by the euro zone crisis to both the economy and to politics. He said the time was right to establish a debt resolution mechanism and said the apparent consensus needed to be harnessed for action. He pointed to the potential impact of recent legal judgements related to sovereign debt, saying a decision made by the Second Circuit Court in New York and another made by the International Centre for Settlement of Investment Disputes could have a negative effect on future negotiations aimed at avoiding default. They opened jurisdictions to potential holdouts by vulture creditors, he warned. There were no regulated procedures for resolving sovereign debt defaults and he suggested that was the case because there was no risk of liquidation for a country, as there was in commercial insolvency law. Pre-determined rules for dealing with such situations would be of great use, though, he argued, providing decision-makers with guidance in an otherwise chaotic situation and reducing confusion. While he acknowledged that legal procedures were not a “golden solution”, he was surprised that no calculations had been made concerning the costs of the absence of such procedures.
He made a plea for the continued use of collective action clauses, which were useful for addressing debt, even if they did not offer solutions for necessary structural reforms. Supplementing collective action clauses with a set of procedures was a sensible approach. Most cases, so far, had been solved through extensive negotiations, but he said that procedures would enable quicker resolution, reducing overall costs because restructuring prior to default was bound to be cheaper than post-default restructuring. Applying the rules while shadow negotiations proceeded alongside would help to make situations more calculable, though he underlined the importance of avoiding a “one size fits all” approach, arguing that alternative approaches like collective action clauses should remain on the table.
The Council then heard presentations on “Ongoing work on sovereign debt restructuring and debt resolution mechanisms”.
YUEFEN LI, Head of Debt and Development Finance Branch, United Nations Conference on Trade and Development, said the proposal for a debt-restructuring mechanism had been viewed as a “game changer”, evoking concerns. There was still a preference for an incremental market approach, such as collective action clauses. She described ongoing work on sovereign debt restructuring and on debt resolution mechanisms, efforts that traced their mandates to General Assembly resolutions and UNCTAD ministerial conferences. UNCTAD followed a two-pronged approach, focusing on debt crisis prevention and resolution, in parallel. Intergovernmental debate and expert discussions were also important for building consensus. The General Assembly special event on “Lessons Learned and Proposals for Debt Resolution Mechanisms”, last October marked the first time that States had agreed the topic should be taken up at the highest level at the United Nations.
Detailing other UNCTAD efforts, she went on to describe five problems with the current approach to sovereign debt restructuring, namely: lengthy debt negotiations which, in some cases, did not restore debt sustainability; delayed defaults; a lack of access to private interim financing; over-borrowing caused by debt dilution; and the need to coordinate dispersed creditors. In February, UNCTAD had held a meeting on how to advance work on a debt restructuring mechanism, where “some shifts of opinion and mood” towards a more favourable perception of such a mechanism had been observed. Also, UNCTAD’s biannual Debt Management Conference in November would examine the creation of a debt restructuring mechanism. In January, UNCTAD launched a sovereign debt restructuring mechanism project, which would last three years.
BENU SCHNEIDER, Senior Economic Affairs Officer, Financing for Development Office, Department of Economic and Social Affairs, discussed the outcome of recent expert group meetings, which examined gaps in the International Monetary Fund’s architecture for debt resolution, saying that when the Fund was established, balance-of-payment problems were dealt with through adjustments in domestic policies and, later, through exchange rates. Today, adjustments and austerity measures were compressed into shorter periods of time, which had led to problems, as seen in Greece and Cyprus. In addition, there was no possibility for the private sector to provide debtor-in-possession financing. The bailout package for Greece was the highest in history, showing the need for some scope for the private sector.
Further, there was no platform for early engagement between debtors and creditors, she said, or ways to work out the relationship between the private and “official” sector. As a result, when a debt crisis occurred, there was much uncertainty. The Fund did not have an exit strategy for such situations and was forced to exercise forbearance. While such elements were missing in the architecture, there was also a larger number of, and diversity among, creditors. The role of sovereign debt had implications for the expansion of “credit with debt” write-downs, which created moral hazard implications for both debtors and creditors.
Addressing why it was important to reform, she said the costs of sovereign debt restructuring were very high, around 5 per cent in output losses a year. Solutions on returning countries to growth and debt sustainability were needed. Among the concerns, creditors felt their rights had been eroded. They had been impacted by preferred creditor status. Debtors were worried about insufficient debt relief and access to finance. The gaps leading to those problems included the lack of a central dispute resolution mechanism and organized representation of all stakeholders. Options for going forward included the creation of ex ante structures to bring about creditor coordination; “standstills”; debtor-in-possession financing; and the creation of an international debt registry, which had received wide support. Other proposals included the formation of a neutral body to engage debtors and creditors to enable a debt-restructuring process.
The floor was then opened for an interactive dialogue with the panellists. Several delegates stressed the link between the global economic crisis and the negative impact it had had on debt sustainability, especially in developing countries. South Africa’s delegate expressed concern over continued debt distress in post-HIPC countries.
Mr. LEWIS responded that, among the reasons was the fact that the World Bank applied different thresholds for measuring debt distress for HIPCs and under the current Low Income Countries Debt Sustainability Framework. The threshold for distress under the Debt Sustainability Framework was lower than under the HIPC, and full relief under HIPC or the Multilateral Debt Relief Initiative did not necessarily ensure they would not be considered distressed under the newer framework. He said that the larger number of countries at apparently higher risk than HIPC would otherwise have identified was part of the World Bank’s vigilance going forward.
He also responded to a question from Sudan’s representative about eligibility under the HIPC Initiative. He said aggressive efforts were being made within HIPC to move forward with Sudan’s entry and that the World Bank was ready to continue pushing it forward and to provide the debt relief to which Sudan was entitled.
A representative of The Debt Network said that the UNCTAD working group on debt sustainability was an “important initiative” and that it would be well placed to take stock of all existing reform proposals and to coordinate the global dialogue towards the adoption of a debt restructuring mechanism.
Responding, Ms. LI said she had seen increases in domestic borrowing and external private borrowing. The exit of current expansionary monetary policy meant there would be more debt servicing responsibility. Problems in servicing debt would be severe for vulnerable States. She highlighted the UNCTAD principles on sovereign lending and borrowing in that regard, saying it was important for creditors and borrowers to act responsibly.
As for a debt restructuring mechanism, she said UNCTAD would start taking stock of proposals and would work with various stakeholders, including civil society and multilateral institutions in that regard.
Ms. SCHNEIDER said debt was a very important source of financing for sustainable development. Voluntary approaches did not work well in times of crisis. The next step was to discuss the “incentive and disincentive structure” so that responsible borrowing and lending could take place, and that high debt burdens did not deter growth. Consensus had been reached on the fact there was a problem, there were gaps in the architecture, and that something must be done to improve the situation.
To the query about a forum for debtors, she recalled that Brazil had proposed a similar idea, years ago, to collectively negotiate the debt of Latin America. At the time, Citibank had worked against it, arguing instead for a case-by-case approach. However, a forum would be a good idea. One proposal she had received from the private sector was for a standing committee to examine proposals and for the United Nations to organize a series of round tables with the “official” sector.
Also taking part in the debate was the representative of China.
A representative of Jubilee USA also made an intervention.
JOSEPH STIGLITZ, Professor, Columbia University, addressed the Council on the “Gaps in legal and institutional structures for debt restructuring”. He said bankruptcy was central to modern capitalist economies, allowing companies a “fresh start” when debt got out of hand. Cross-border capital flows were also central to modern capitalism and large amounts of debt flowed across borders. Nonetheless, there was no established way of resolving excessive indebtedness when it affected sovereign States. Efficiency and equity demanded sovereigns be granted the same right to a “fresh start” afforded businesses, because of the “enormous waste of resources” caused by high sovereign debt. Better institutions would make both creditors and debtors better off, he argued.
He said there was a tendency to blame borrowers when debts became too high but every contract had two sides, both of which were voluntary. Lenders, therefore, were as responsible for debt distress as borrowers. They were guilty of lending too much and were usually more financially sophisticated than borrowers, with better risk assessment capabilities. The fact that they still lent so much showed they were guilty of “predatory lending”. In Sub-Saharan Africa, Western banks were currently pushing countries to borrow too much. Creditors often gave loans with an expectation that excessive debts would be socialized by a Government and that the IMF could be relied on for a bailout. Many poor countries were unable to access concessionary financing, but had access to high interest loans.
A bankruptcy regime could facilitate the flow of capital to maximize growth, while minimizing hardship following crises and reflecting the concerns of all parties, including developing countries. Risks, delays and the magnitude of crises would all be reduced by a bankruptcy regime that resolved problems quicker and more certainly.
He noted several problems with sovereign debt restructuring, pointing out that the legal framework would be difficult to enforce, even more so in an era of privatization. There was a framework for domestic cases, but none for international cases. Domestic bankruptcy was also subject to the “priority” of claimants, which contained the understanding that there were limits to debtors’ abilities to pay and that certain creditors deserved to be paid first. In sovereign debt, it was much more difficult to work out who the claimants were and how their claims were to be measured and compared. There were a variety of political and economic and agency problems, he said, including the fact that Governments that entered into debt deals may not be the same Governments that faced the impact of debt distress.
Restructuring could help countries deal with problems like Keynesian unemployment, he said, allowing them to use the money to stimulate. Deeper restructuring was better, because shallow restructuring was likely to just delay the ultimate need for restructuring. Nonetheless, the high short-run costs of restructuring meant political leaders would try to postpone the day of reckoning as long as possible. Currently, incentives existed for that delay, so a sovereign debt restructuring mechanism was needed to give a State an incentive to work its way out of excessive indebtedness safely and sensibly.
He said that market solutions alone would not work. Domestic bankruptcy mechanisms existed specifically because of that fact. The same was true internationally and that underlined the need for a legal framework. Market solutions would handle conflicts of interest between claimants, as well as debt valuation and issues of priority in an inefficient or unfair manner. Courts could help to ensure inefficiency and delays were reduced. Market centred solutions like collective action clauses were not adequate, he said. The development of the derivative market had further complicated matters and made things worse. It had resulted in a situation where sitting at the table in debt negotiations were people with no interest in a solution; people who might in fact have an interest in negotiations failing. That helped to increase the imperative to develop an alternative. One important innovation he pointed to was GDP-linked bonds, which provided an incentive for the creditor to see the borrower succeed. It was a clear improvement, but had been resisted by the financial markets, he noted.
He proposed a world bankruptcy organization, independent of the IMF, which he believed to be too closely linked to creditors. He proposed a process for resolving debt issues efficiently and fairly and acknowledged that establishing such an organization would not be possible overnight. An intermediate solution was required and he suggested that it would work in much the same way, but with “mediation” and “soft laws” instead of court rulings.
In the afternoon, the Council held a panel discussion, entitled “Architecture for debt restructuring”, with presentations by each panel member.
SERGIO CHODOS, Alternative Executive Director, International Monetary Fund, focused on improving the architecture for debt restructuring, emphasizing that market solutions did not work in large part because the vast array of stakeholder interests were not aligned. “There’s no logical incentive to align the incentives,” he said. A hedge fund that bought in the secondary market, for example, was not a lender. It was a claimant, but it did not behave like a primary buyer or a direct lender, or even a vulture fund that purchased after default — and then pushed for default. The main problem had been one of incentives.
In addition, he said, financial markets had a disproportionate bearing versus other stakeholders, such as pensioners and private citizens. There was a prevailing mantra that market access was the only way to surmount the hurdle. The emphasis on access as the one way to judge whether a restructuring was successful had complicated the situation. Problems would continue unless the repayment capacity of the borrower was placed at the core of the solution and a way was found to align the various stakeholder incentives. He conceded that such a view contravened conventional wisdom. But, unless the outcome was taken into account — from the start — and the structure was crafted accordingly, problems would persist. He also agreed with Mr. Stiglitz on the features of a debt restructuring mechanism.
HANS HUMES, Chairman and Chief Executive Officer, Greylock Capital Management, LLC, said he had worked on economic restructuring in Nicaragua, Russian Federation, Ecuador, Argentina and others. Most recently, he served on the Steering Committee in Greece. The big problem leading to restructuring was the delay of getting to the table. In the case of Greece, in a round-table discussion in Washington, D.C., those from the private sector were able to flag that Greece was headed in an unsustainable direction and that its debt-to-GDP ratio was way too high. He pointed out that it was the cost of debt servicing, rather than the actual debt, that imposed most on the economy. Calling attention to a country that had an unsustainable debt portfolio was important, he said, but warned against “dragging a country kicking and screaming to the table”.
Creditors paid attention to sovereign debt problems and acted pre-emptively, as was the case in Cyprus, where “everything was on the table”, Mr. Humes said. More broadly, what had occurred since 2001, and particularly in the last six and seven years, was a sign of improvement, showing that the turnaround time of restructuring had become quicker. In Greece, holdouts in the private sector were incidental and official sector creditors were carrying about a quarter of the country’s debt. He expressed caution about the “behind the scenes” restructuring that was going on, and said it was important to focus on the things that were working, because with those it would be easier to build consensus.
DEBORAH NACHE-ZANDSTRA, Partner, Sovereign Debt Restructuring Group, Clifford Chance, focused on the concept of a “standstill”, saying that English and New York law bondstypically included events of default. Bond documents often contained grace periods to address short-term problems that could be fixed. They were not intended to operate as a standstill period or a restructuring tool. They did not provide the sovereign debtor with a sufficiently prolonged period of time to come to the table with its creditors and agree on appropriate deferrals or waivers. There were a number of ways standstills could be activated, notably through a formal bankruptcy, within a process built around a debt restructuring, or through the inclusion of a contractual standstill mechanism as part of an incremental market approach.
Among the benefits, a standstill could provide a sovereign and its creditors with financial stability in which to decide on a restructuring plan, she said. It could prevent the “cross default” and acceleration of obligations, as well as litigation, but in a sovereign context, litigants tended to wait until a restructuring was on the way to implementation. It also could create a framework in which a better set of priorities could be established. One-size-fits-all solutions were not necessarily best in that context.
She went on to say that the scope of the standstill would need to be agreed, with questions focused on whether there should be a deferral of interest payments — or a broader cessation of payments. Should the standstill include a legal stay on litigation? Thought also must be given to the work to be undertaken during the standstill period, and most importantly, who would trigger the standstill. It would be most effective for the debtor to do so. The challenges included risks that credit default swaps would be triggered, ratings would be downgraded and assets impaired. Discussion also should centre on whether standstills could be useful in liquidity, as opposed to a solvency crisis.
LEE BUCHHEIT, Partner, Cleary Gottlieb Steen and Hamilton, said that holdout creditors represented both a financial and an emotional risk. When designing a sovereign debt programme, the architect assumed that the creditor would lend to the debtor the total funds needed, which was often not the case. The sovereign debtor imposed bitter austerity measures, while the creditor wrapped itself around the legal sanctity, demanding repayment. The trend of lending 100 cents on the dollar, but accepting a package of 50 per cent payback, stirred a kind of “emotional antipathy” in the lender. There were many techniques in dealing with that, for example the “carrot and stick” approach. In designing a debt structuring mechanism it was possible to include creditors’ view of how the market would evolve.
In addition, it was possible for debtors to give creditors an incentive by pledging to pay off the debt if things in the debtor country went well down the road. For example, in the past oil exporters gave their creditors the promise that if the price of oil increased, they would share that with its creditors. It served as a financial inducement, he said. In other cases, the restructuring could link to the performance of a loan as sovereigns typically paid back the World Bank, IMF and IDB. Those were inherently unpleasant transactions, as “someone must lose money”. The “one ubiquitous stick” in the carrot and stick approach remained the threat of non-payment. The extent to which the sovereign was explicit about the threat of non-payment was a “matter of taste” — some countries were quite bold, he added. Other techniques included focusing on the non-payment terms, such as the waiver of sovereign immunity and the choice of governing laws, which was a matter of interest to the holder. It was now the norm to include collective action clauses, by which a supermajority could vote to restructure the payment terms and have that decision be binding.
JAMES HALEY, Executive Director, Inter-American Development Bank, said “we’re dealing with a problem that has been with us forever”. The global financial system had changed, but the financial architecture to support it largely had not. In an earlier age, if a sovereign owed another sovereign, the creditor would send in gun boats and take over the customs house. We now live in a post-Bretton Woods era: one in which the capital controls that had supported the Bretton Woods consensus after the Second World War had largely been eroded, as countries had sought the benefits of increased financial integration and capital market openness. In the past, balance-of-payment problems were typically current account problems — those of “flows”. Today, with capital restrictions removed, balance-of-payment problems were financial sector crises that involved converting stocks of assets, not flows.
He said the result was that the burden of adjustment on countries was correspondingly much larger. The IMF, by working to achieve a judicious balance between financing, on the one hand, and adjustment on the other, was trying to catalyse private capital through its lending. When that worked, as in Brazil 10 years ago, it avoided economic disruption. When it did not, the result was protracted economic downturn. But, it did not have the tools to do anything else. To address those problems, one solution was to endow the Fund with resources to become a global central banker. There was no consensus to do that and it might not be the right way to go. Another option involved broadening the definition of adjustment to include adjustment of private-sector claims on the sovereign.
But what was missing in the architecture was a meaningful way to promote the orderly restructuring of private claims, he said. One view of the future viewed voluntary approaches as imperfect, but an improvement on what had been feared a decade ago. Another view argued that the Fund should try to strike the judicious balance between financing and adjustment. In sum, to achieve a voluntary restructuring, there must be a threat of coercive measures. Those threats existed today in the form of force majeure and the doctrine of sovereign immunity. “Life after debt” envisioned a very different world going forward and the time might be right to explore a formal debt restructuring option.
In the discussion that followed, the representative of Belize said she was well aware that sovereign States were responsible for their fiscal austerity. At the same time, not caving to the IMF “cocktail of unbridled privatization” had left her country with no support. A formal IMF programme was presented as the only possible option, demanding policies that would drive more Belizeans into poverty. Belize was too small to save, she said, saying that today’s bankers were similar to those described by Mark Twain, people who gave an umbrella when the sun was out, and took it away when it started to rain.
Surely, she said, the IMF and the World Bank were capable of supporting small and fragile economies like Belize’s. Emerging economies deserved an increased voice, tailored solutions, and rewards conducive to the survival of the planet. The current economic environment was medieval, she said, adding that a shift in commodity prices, terms of trade and the inescapable business cycles had to be considered before moving forward. Unsustainable debt was unsustainable at the time of lending. A seminal lesson of the recession was that ineligibility should not invite a “choke hold” of lending.
Mr. HUMES, echoing the concerns of Belize’s representative, said that most recent press stories about countries that had implemented IMF policies, showed a deterioration of health and increase in mortality rates. Some Governments were left to make a choice between paying creditors back and paying for the health care of their populations. He said not everyone would agree with him, but he believed that the health and well-being of a population should be more of a priority for Governments than paying back a creditor. Specifically in the case of Belize, there had been posturing on both the sides — creditors and country — in getting a deal that would be acceptable on both sides.
The representative of Ecuador asked the panel to elaborate on Greece’s debt restructuring, distinguishing between the different types of creditors and additional measures which could be adopted. One such measure adopted by Ecuador that was successful, led to a savings of $7 billion and a significant decrease of debt, which meant it had been able to allocate more funds towards social programmes.
Mr. HUMES said at the verge of signing the deal of halving the debt, the European Central Bank took stock of bonds and did a swap beforehand, so that they would not get a haircut. That contributed to the debt problem. The European Union lent Greece $10 billion to reduce its debt-to-GDP ratio to 124 per cent. Although it provided a boost in the price market, what was needed was for the official sector to reduce its debt. He said he had participated in Ecuador and was part of the discussion on what to do on the issue of odious debt. At face value, it made sense because there was so much grey area, he said, adding that none of the processes was perfect and accommodations were essential.
The representative of Iraq said the new Government had to cope with dealing with the financial problems of the past. Therefore, what happened during the Saddam regime should be seen more as an important lesson — lenders should better engage and oversee where the money was going. It so happened that, in Iraq, it was used to fuel wars. Countries and private institution lending, when it came to hundreds of billions of dollars, just like every banker, had to be engaged to see what the money was being used for. That turned out to be not just disastrous for the region, but also for the Iraqi people.
Responding to Iraq’s delegate, Mr. BUCHHEIT said that there was nothing subtle about the Saddam regime and people who lent to it knew precisely what they were doing. There was a moral case to be made against the creditors who backed Saddam. They had made a choice, he said. The lenders had a responsibility and if they saw that the money lent was not being employed, they ought to be on notice.
The representatives of Switzerland and New Zealand also spoke.
In concluding remarks, Mr. OSORIO said the debt problem was no longer confined to developing or emerging market economies. Many indebted countries were in the developed world, which carried significant implications for systemic risks to global financial stability. The costs associated with sovereign debt restructuring had been high for debtors and creditors alike. There were gaps in the architecture for sovereign debt restructuring. The analogue of domestic bankruptcy courts did not exist for international sovereign debt bankruptcy; the lack thereof was a real cost to countries in debt distress.
He said that, since the demise of the sovereign debt restructuring mechanism a decade ago, improvements in the architecture had been made for creditor coordination, through the introduction of the collective action clause in bond contracts and a voluntary code of conduct. But, experience showed that that was not enough to deal with debt overhang. Today’s debate had heard eloquent proposals for improving the debt restructuring architecture, ranging from voluntary approaches, to a combination of voluntary and statutory measures. Work must proceed with a view to examining existing proposals and finding the best way forward. “We should be practical but not set our expectations too low,” he said, adding that the Council was well positioned as a forum for analysing different views, as well as addressing the consequences of both action and inaction.
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