I. Introduction
This paper examines the experience of the International Bank for Reconstruction and Development (IBRD)—more commonly known as the World Bank—and the International Development Association (IDA) (hereinafter collectively referred to as “the Bank”) in cofinancing development projects and programs with various external financial sources in the Bank’s developing member countries (DMCs). It also discusses recent events in the heavily indebted countries (HICs) and how the Bank is working to facilitate the flow of new development financing to these countries.
The Bank’s efforts to promote cofinancing must be viewed in the context of its broader constitutional mandate under its Articles of Agreement, which charge the Bank with the primary role of assisting in the development of its member countries by “facilitating the investment of capital for productive purposes” and which more specifically provide that the Bank shall “promote private foreign investment by means of guarantees or participations in loans and other investments made by private investors” and “encourag[e] international investment for the development of the productive resources of members.” The Articles also stipulate that the Bank is not to compete with other sources of financing. Only when the Bank is satisfied that financing for a particular project is not available on reasonable terms may it supplement private investment by making loans directly out of its own capital, with funds borrowed from the international capital markets, or its other resources. Although the Bank is the largest international development financing institution in the world, its resources are limited and represent only a small fraction of the total resource requirements of the DMCs. Because of the limitation imposed by the Bank’s Articles and its resources, the Bank’s role is primarily that of a catalyst and lender of last resort.
However, the future outlook for capital flows to the DMCs is not very promising. Voluntary private foreign direct investment in the DMCs has declined considerably in recent years. Levels of official development assistance from bilateral sources and export credit agencies have fallen dramatically, mainly owing to low rates of growth in the industrialized countries. Since the outbreak of the debt crisis in 1982, commercial banks have also significantly reduced their exposure to the DMCs. The serious debt-servicing problems of many DMCs, which have led to many rescheduling exercises in recent years, and the precarious economic positions of others are making lenders, banking supervisors, and investors more conscious than ever of country risk. In the face of this severe contraction in investment and lending, the role of the Bank in mobilizing resources for the DMCs through cofinancing and other measures has assumed increased significance.
II. Scope of Cofinancing Operations
The term “cofinancing,” as used in this paper, describes an arrangement in which the Bank and one or more other external financial sources agree to finance a substantial portion of the cost of a development project or program in a DMC or in which the Bank guarantees a portion of the loan made by an external financial source. The Bank receives funds from a variety of sources for cofinancing development projects and programs. During the fiscal year 1987 (July 1, 1986–June 30, 1987), the Bank was able to mobilize about US$5.6 billion in cofinancing from all external sources. The four main sources of cofinancing are described in the following subsections.
Bilateral Lending Agencies and Multilateral Financing Institutions
Historically, the Bank’s main partners in cofinancing development projects and programs in the DMCs have been official lenders, namely bilateral lending agencies and multilateral financing institutions. Examples of bilateral agencies are the U.S. Agency for International Development, the United Kingdom’s Overseas Development Administration, the Federal Republic of Germany’s Kreditanstalt fur Wiederaufbau, Japan’s Overseas Economic Cooperation Fund, France’s Caisse centrale de cooperation economique, the Canadian International Development Agency, the Kuwait Fund for Arab Economic Development, and the Saudi Fund for Development. The principal multilateral financing institutions which have been involved in cofinancing operations are the United Nations Development Program, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the International Fund for Agricultural Development, the European Investment Bank, the European Community, the OPEC [Organization of Petroleum Exporting Countries] Fund for International Development, and the Arab Fund for Economic and Social Development.
Official lenders share a common developmental orientation with the Bank and, as such, have had a long and close association with it. Both in terms of the volume of funds and the number of operations, official development assistance has been the single largest source of cofinancing. In recent years, official lenders have accounted for about half of all cofinancing in Bank-assisted operations.
Export Credit Agencies
Many of the industrialized countries have established national export credit agencies to promote their exports. Examples of these are the U.S. Export-Import Bank, the Export-Import Bank of Japan, the United Kingdom’s Export Credit Guarantee Department, and France’s Compagnie francaise d’assurance pour le commerce exterieur. Export credit agencies either provide the financing for exports themselves or they provide insurance or guarantees for commercial bank loans or supplier’s credits extended to finance exports.
The number of projects which the Bank has cofinanced with export credit agencies is quite limited. For example, over fiscal years 1986 and 1987, the Bank has cofinanced about 30 such projects for a total amount of about US$2.5 billion. The very nature of export credits, which are generally tied to procurement of goods from the country of export and restricted to large equipment contracts, limits the number of cofinancing possibilities.
The important thing to note about export credit agencies is that they are not development institutions, but rather export promotion agencies. However, export credit agencies are becoming increasingly aware of the linkage between trade and development, particularly in the HICs. Without development, export markets for industrial country products in the developing countries are likely to shrink and the debt-servicing capacity of these countries is likely to diminish. In March 1987, the Export-Import Bank of Japan took an important step forward by signing a framework agreement with the IBRD under which an untied loan facility was made available for the cofinancing, with the Bank, of high-priority economic-adjustment programs and investment projects.
Private Commercial Banks
Since the mid-1970s, the largest pool of external finance available to the DMCs has been provided by private commercial banks. Much of this lending was in the form of syndicated Eurocurrency loans. Beginning in 1975, when the first syndicated loan was made alongside a World Bank loan, the association between the Bank and commercial banks has broadened considerably, involving more than four hundred banks from the United States, Japan, Canada, Europe, and the Middle East. In recent years, commercial bank lending has accounted for about 20 percent of the volume of all cofinancing in Bank-assisted operations.
Traditionally, commercial banks have provided balance of payments loans to the DMCs. Many DMCs found this type of borrowing attractive because the loans were large and quick-disbursing and there were no restrictions on the use of the loan proceeds. Since the outbreak of the debt crisis in 1982, commercial banks have become wary of making balance of payments loans and have actively sought to associate their lending to the DMCs, particularly to the HICs, with the operations of the Bank, the International Monetary Fund, and the regional development banks.
Types of Cofinancing
The specific arrangements involved in cofinancing, and particularly the role of the Bank, vary from case to case. Most of the Bank’s cofinancing operations take the form of either parallel financing or joint financing. In a few cases, cofinancing has taken the form of partial guarantees of loans by other lenders. Under parallel financing, the project is divided into specific and identifiable segments for separate financing by the Bank and one or more cofinanciers. This form of cofinancing is suitable for sources of both tied and untied funds. Tied funds are those whose use is essentially limited to financing goods and services from the sources of cofinancing. Under joint financing, funds from the Bank and the cofinanciers are pooled to finance a common list of goods and services in certain agreed proportions. These goods and services are procured in accordance with the Bank’s procurement guidelines. Such cofinancing is generally feasible only with institutions which provide untied funds and impose no special procurement restrictions.
Official cofinanciers generally prefer to be involved in parallel financing, so that their funds may be clearly identified with separate project components and because bilateral official assistance is frequently tied to procurement for the country of the official lender. When export credit sources are tapped, the parallel-financing formula is used, since export credits are generally tied. Funds from commercial banking sources, however, are generally untied and may be used in both parallel and joint financing.
III. Cofinancing with Official Sources
Terms of Assistance
There are two distinctive characteristics of financing provided by official lenders. First, it is provided to encourage the achievement of development objectives and, as such, is in harmony with the purposes for which Bank loans are made. Second, official development assistance, particularly that from bilateral aid agencies, is frequently provided on concessionary terms. The concessionary terms generally involve low interest rates, long repayment periods, or—sometimes—grant financing. Loans from multilateral financing institutions are generally provided on market-related, as well as concessionary, terms. Since many of the poorer DMCs cannot afford to borrow on commercial or market-related terms, they generally turn to the bilateral agencies or to the soft-loan windows of the Bank (IDA) and the other regional development banks to meet all or most of their financing requirements. Export credit agencies are not development institutions and, as such, the funds which they provide, guarantee, or insure are generally provided on close-to-market terms and, in certain cases, with some element of subsidy provided by the government of the exporter’s country.
Procurement Restrictions
The assistance provided by official lenders is frequently tied to procurement from the country of the official lender. Recent exceptions to this rule are the Netherlands and Japan. By definition, export credit financing involves tied procurement. Such procurement restrictions are not, however, compatible with the Bank’s own procurement policies and procedures, which generally require that contracts be awarded on the basis of international competitive procedures among suppliers and contractors in all of its member countries. Therefore, where the cofinancier’s funds are provided with such procurement restrictions, parallel financing arrangements are worked out for the cofinancing operation—that is, the Bank and the colender finance different goods and services, or different components of a project, under separate loan agreements.
One of the principal attractions which cofinancing operations with the Bank offer to official lenders—apart from the Bank’s technical expertise, country experience, and sound appraisal procedures—is Bank supervision of the implementation of cofinanced projects. Where the official cofinancier’s funds are provided on an untied basis, the Bank is willing to administer the cofinancier’s funds and to supervise the procurement process closely. In such cases, the Bank enters into administration agreements with cofinanciers spelling out the specific cooperation arrangements. However, where the cofinancier’s funds contain procurement restrictions, the Bank is not able to administer the cofinancier’s funds or to supervise the procurement process closely, since the latter is not carried out in line with the Bank’s procurement guidelines. Nevertheless, even where the cofinancier’s funds are tied, the Bank satisfies itself that the goods and services procured by the borrower are acceptable in terms of both quality and price, and that the procurement arrangements are consistent with the overall financial soundness and timely implementation of the project.
Consultation/Exchange of Information and Cross-Default Clauses
Virtually all of the cofinancing arrangements with official cofinanciers and export credit institutions provide for close consultations and exchanges of information between the Bank and the cofinanciers. Provisions are frequently made for joint participation in project-supervision missions and for consultations before the taking of remedial measures, such as suspension and acceleration of loans. The information the Bank agrees to share with the cofinanciers is usually limited to nonconfidential information concerning the implementation of the project and—sometimes—the economic conditions in the borrowing country.
Additionally, the Bank’s loan agreement and the cofinancier’s loan agreement usually incorporate an optional cross-default clause under which the Bank or the cofinancier, as the case may be, would have the right to suspend, terminate, or accelerate its own loan if the other lender took similar measures. Such a clause is reasonable, since it is designed to ensure coordinated action among the lenders and the integrity of the financing plan for the project.
IV. Cofinancing with Commercial Banks
Introduction of the B-Loan Cofinancing Program
In January 1983, the Executive Directors of the Bank approved the establishment of a new set of cofinancing instruments which are specially designed to accelerate the flow of private capital, on improved terms, to its borrowing member countries. This set of instruments, popularly known as the B-loan program, seek to link the finance provided by commercial banks more closely with that provided by the Bank. The main feature of this program is that the Bank, in addition to making its own loan for a project (the A-loan), participates in the parallel commercial bank loan for the same project (the B-loan). The A-loan carries the Bank’s standard lending terms while the B-loan essentially carries the normal commercial terms applicable to syndicated loans. The Bank’s participation may take the form of direct funding of the later maturities of the commercial bank loan, the provision of a partial guarantee, or the acceptance of a contingent commitment with respect to a portion of the commercial bank loan.
The objectives of the B-loan instruments are to provide borrowers with improved and more clearly identifiable benefits from cofinancing and to mobilize larger volumes of cofinancing for Bank operations. To achieve these objectives, the B-loan instruments provide the commercial banks with greater “comfort” or assurance of protection for their loans. The Bank’s financial presence in the commercially syndicated loan (the B-loan), over and above the normal Bank loan (the A-loan), represents a positive new factor for commercial banks in the evaluation of credit risk, and B-loans therefore tend to have more favorable terms and, in certain cases, to bring additional amounts of capital to borrowers.
The B-Loan Instruments
It is appropriate now to examine briefly the three cofinancing instruments available under the B-loan program.
Direct Financial Participation
Under this first option, which has been most frequently used so far, the Bank directly participates as a lender in the commercially syndicated loan in much the same way as the commercial banks in the syndicate. It does this by funding the later maturities of the commercial loan. The size of the Bank’s participation in the commercial loan has ranged from about 10 percent to 25 percent.
The Bank’s funding is intended to induce the commercial banks to extend the maturities of their portion of the loan beyond those they would otherwise offer the particular borrower, and the Bank maturities are added after that extended period is established. Thus, for example, if a borrower could normally obtain a commercial credit with a six-year maturity, the Bank would offer its funding for year eight and seek a lengthening of the commercial bank maturity from year six to year seven in order to meet the late maturity being financed by the Bank.
Guarantee
Under the second option, the Bank guarantees the later maturities of a loan made and funded wholly by commercial banks, instead of directly funding them itself. Alternatively, the Bank could structure its guarantee as a “put” option on the later maturities of the commercial loan, thereby giving the commercial lenders the right to sell, and the Bank an obligation to purchase, the designated maturities at the request of the lenders. As required by its Articles of Agreement, the Bank would charge a fee for issuing and maintaining a guarantee.
Contingent Obligation After Level Payments
The third option involves the Bank in taking a contingent participation in the final maturity of a commercial loan designed with a fixed level of installments that combine floating-interest and variable-principal repayments. If the interest rate should rise above the initial rate used to determine the fixed level of installments, the amortization of the loan would not be completed on the original schedule, and the Bank would accept an obligation to finance the final repayment if the commercial banks were not willing to finance the balance of principal outstanding, if any, at final maturity.
Review of B-Loan Cofinancing Experience
Since the B-loan program was approved in January 1983, a total of 22 individual B-loan transactions have been concluded. Most of these have involved the use of the direct funding option; six have involved the use of guarantees; and one has involved the use of the contingent obligation. Twelve DMCs (Algeria, Brazil, Cameroon, Chile, Colombia, Hungary, Côte d’Ivoire, Mexico, Paraguay, Thailand, Turkey, and Uruguay) have benefitted from the B-loan program. As of April 30, 1988, the total amount of funds generated from commercial banks under B-loan cofi-nancing operations is over US$4 billion. All major money center banks and smaller regional banks from North America, Europe, Japan, and the Middle East have participated, with more than four hundred banks joining in the syndications.
The record so far may be described as reasonably good, given the economic circumstances prevailing in the last five years. The onset of the widespread debt crisis in 1982 and the ensuing difficulties faced by several of the DMCs who had previously been considered creditworthy for commercial loans added a complex set of market constraints to the environment into which the B-loan program was introduced. These difficulties—particularly for Latin American, African, and Eastern European borrowers—led to a preoccupation by commercial banks with the short-term aspects of the crisis and the risks of rescheduling, and have resulted in a diminished scale of voluntary lending for DMCs as a whole. For the HICs, most lending has taken place as part of concerted lending operations.
The B-loan cofinancing instruments have stimulated the flow of capital into DMCs on better terms and in larger volumes than would otherwise have been possible. The benefits which have accrued to borrowers from the B-loans are varied and significant. The more specific tangible benefits which borrowers have enjoyed include the following: regaining access to the syndicated loan market, improving such access once it has been regained, and resumption of voluntary lending operations in a debt-ridden region. As for lending terms, the most significant improvement has been the substantial lengthening of maturities (by two to three years, on the average) and even of grace periods. To a lesser extent, some modest improvements in pricing of B-loans, compared with the terms of preceding borrowings by the same borrower, have been achieved. These improvements include slightly lower spreads and front-end fees, better sell-downs, and greater flexibility for borrowers in their choices of currencies borrowed.
V. Special Legal Provisions of B-Loan Cofinancing Agreement
The advent of the B-loan program has brought to the fore certain unique legal issues which arise from the “coexistence” of the Bank and private banks in a single commercially syndicated loan transaction.
The essential feature of syndicated loan agreements is their highly commercial character. The interest rate applicable to such a loan is governed by commercial market terms (e.g., for Eurocurrency loans, a margin above the London interbank offered rate, or LIBOR). Repayment and grace periods are generally shorter than those provided by the Bank, and drawdowns are quick in order to ensure maximum profitability for the lenders. The law governing the agreement is usually that of the lender’s country, or New York State, or England. All or most of the provisions of the loan agreements are primarily designed to ensure the loan’s collectibility, which has been aptly characterized as the “front-end legal consideration” affecting its structure. This explains the extremely complex, comprehensive, and lengthy provisions of the loan agreements drafted by lawyers handling syndicated loan transactions.
On the other hand, the Bank’s loan agreements reflect its developmental character. The Bank uses a much simpler form of loan agreement, into which are incorporated by reference certain general conditions which apply to the loan and the Bank’s guidelines for carrying out procurement and engaging consultants to be financed under the loan. The essential feature of these legal provisions is that the Bank closely monitors the use of the proceeds of its loans to ensure that they are used, as required under its Articles of Agreement, for the purposes of the project being financed, that the funds are disbursed as project expenditures are actually incurred over the entire implementation period of the project, and that economy and efficiency are ensured in procuring goods and services for the project. The borrower is required to maintain records and accounts of the projects; the accounts are audited annually by auditors acceptable to the Bank; and progress reports and audited accounts are submitted to the Bank periodically for review. The Bank’s loan agreements are also characterized by the inclusion of a number of project-related or “developmental” covenants, such as undertakings by the borrower to reorganize large and inefficient institutions, to review its pricing policies, to increase tariffs, and to undertake special studies; in several of these instances, the borrower is required to consult with the Bank in carrying them out.
The documentation that has been used in B-loan transactions has taken substantially the form of the usual commercially syndicated loan agreement, which is prepared by the lead managing bank. There have been some minor variations in the form and language of each loan agreement, reflecting the practices of the relevant marketplace (e.g., the U.S., Japanese, European, or Arab banking system); the preferences of the lead managing bank and its lawyers; and, to a limited extent, the kind of documentation that has been previously used in the borrowing country concerned. Subject to these variations, the B-loan agreement has incorporated the usual boilerplate provisions. In addition, the Bank has sought to add certain new provisions or amendments to existing provisions designed to reflect the Bank’s participation in the commercial loan. Some of these provisions are required by the Bank’s Articles of Agreement; some are intended to protect the Bank itself; some are intended to reflect the Bank’s special relationship with its member countries and its preferred creditor status; and others are intended to provide various measures of “comfort” sought by the commercial banks within the context of each cofinancing transaction.
It is useful now to examine how the separate and mutual interests of the Bank and the commercial banks have been safeguarded through the inclusion of certain unique provisions in B-loan agreements. A considerable amount of goodwill, appreciation of each other’s positions and interests, compromise, and creativity on all sides has gone into fashioning these special legal provisions designed to reconcile the Bank’s concerns as a development institution (including such aspects as the Bank’s preferred creditor status, its special relationship with its member countries, and the sensitive nature of its developmental covenants) with the private commercial interests of the commercial banks.
Monitoring Use of Loan Proceeds
As required by its Articles of Agreement, the Bank places definite limitations on the use of the proceeds of its loans to ensure that they are used only for the intended purposes and that due attention is paid to considerations of economy and efficiency. Under the B-loan agreements, the Bank has required that the purpose of each loan be clearly specified in the description of the project and the components to be financed, usually by means of a cross-reference to the Bank’s A-loan agreement. Special provisions are included to ensure that the proceeds of the loan will be disbursed and used for that purpose and to enable the Bank to monitor such use. These provisions have generally been accepted by the commercial banks, which welcome the Bank’s monitoring of the use of funds, as a necessary feature of project financing.
Under the Bank’s normal disbursement practices, the proceeds of its loans are usually drawn down over the entire project implementation period as required to cover expenses on the project as they are actually incurred. However, under particular B-loan programs, the Bank has had to accommodate the interests of both the private banks and the borrower for a quick drawdown, usually within weeks or months of the signing of the loan agreement. Therefore, the B-loan agreement has usually spelled out arrangements for the establishment of special accounts by the borrower or its central bank in which the loan proceeds will be deposited, with such proceeds available for project disbursements as and when required. Such accounts are subject to annual reporting and audit requirements in line with normal Bank procedures.
In practice, it has not been too difficult to harmonize the Bank’s strict procurement rules with the flexibility traditionally afforded to borrowers in commercial lending transactions. Where the Bank takes a direct financial participation in a B-loan, the Bank’s policy simply requires that an equivalent amount of the B-loans proceeds be used to finance goods and services procured in accordance with the Bank’s procedures. Funds advanced by the commercial banks may, however, be used to finance procurement that is carried out with due attention paid to considerations of economy and efficiency. This applies to all three B-loan instruments. A clause to this effect is included in the B-loan agreement. Additional clauses spell out the arrangements to be followed for maintaining records and accounts and for the audit of accounts.
Nonrescheduling of B-Loans
Under the B-loan program, an issue that is of considerable interest and importance is the rescheduling of commercial bank loans to developing countries. The several recent debt-rescheduling exercises have brought this issue to the forefront of discussions concerning lending to developing countries experiencing serious debt-servicing problems.
The prospectuses issued by the Bank in connection with its borrowings state that the “Bank follows a policy of not taking part in debt rescheduling agreements.” The Bank’s policy of not taking part in rescheduling is influenced by several factors. In marked contrast to commercial bank loans, which are drawn up with profitability and portfolio considerations in mind, Bank loans are development-oriented and are frequently made to finance high-priority investments designed to enhance a country’s credit-worthiness, thereby improving its access to other funding sources. Furthermore, the Bank is concerned with the overall development program and external debt situation of a borrower, and must consider any action it might take in relation to a specific loan in the context and strategy of its lending program to that country. The Bank has a special relationship with its member countries and borrowers, and it remains a lender and adviser even when the country is experiencing serious economic and financial difficulties. Finally, and most importantly, Bank loan maturities and grace periods are already long and are tailored to facilitate the servicing of the loan, both being designed with the time frame required to generate project revenues and an assessment of the borrower’s general future ability to repay kept in mind.
When they were approving the B-loan program, the Executive Directors of the Bank expressed particular concern that participation in cofinancing loans should not lead to the Bank’s being drawn into debt-rescheduling agreements. When the Bank has taken a direct financial participation in a B-loan, it has therefore required that the loan agreements include an express provision to the effect that the commercial banks recognize the Bank’s policy of not taking part in debt-rescheduling agreements, thus ensuring that the Bank’s portion of such a loan would be excluded from any rescheduling if that ever became necessary. On the other hand, since the commercial banks are offering better terms to the borrowers than would normally be available to them in the marketplace, and since they are colenders with the Bank, they also expect their portions of the loan to be insulated from general commercial bank debt-rescheduling exercises—in other words, they assume they can take shelter under the Bank’s “preferred creditor” umbrella. However, the Bank is not in any position to guarantee that commercial bank portions of cofinanced loans would be kept out of reschedulings. All that the Bank can do is to exert its best efforts to defend the commercial banks’ portion of a loan against rescheduling, as and when necessary, with the advisory or steering committees of commercial banks responsible for dealing with debt-rescheduling proposals.
It is significant to note that where the Bank has taken a direct financial participation in a B-loan, all the parties—the borrower, the commercial colenders, and the Bank—have agreed that the entire cofinancing loan obligations are not to be rescheduled without the Bank’s consent. At the same time, the relevant clause in the B-loan agreement implicitly recognizes that there may be certain circumstances under which a rescheduling of the commercial banks’ portion of the loan may take place. Such an agreement would not, however, extend to the portion of the loan due to the Bank.
Sharing of Debt-Service Payments
A key clause in syndicated loan agreements provides for the sharing of debt-service payments among all the lenders in the syndicate. Under this sharing clause, which is included in all B-loan agreements in which the Bank has taken a direct financial participation, the lenders agree to share loan-service payments received from the borrower on a pro rata basis in order to ensure that no one lender is placed in a more favorable position than its colenders at the discretion of the borrower. Typically, this pro rata sharing is achieved by means of an agreement to pool all payments received in the hands of an agent, who then distributes the proceeds to all lenders on this basis. Because the Bank enjoys preferred creditor status, commercial banks obtain such special benefits as this sharing arrangement when they participate in a B-loan agreement in which the Bank has a direct financial participation.
One important qualification to the general rule on pro rata sharing applies when some or all of the commercial lenders participating in a B-loan decide to reschedule their portions of the loan. In view of the Bank’s position that it will not take part in any rescheduling agreements, when the Bank takes a direct financial participation in a B-loan, the loan agreement contains an exception to the general rule specifying pro rata sharing whereby the Bank is not required to share payments received with any colender which consents to, or takes any other action with respect to, rescheduling of any of the borrower’s repayment obligations under the loan agreement.
Cross-Default Clause
A cross-default clause is a provision in a loan agreement which entitles the lender to suspend disbursements and/or accelerate repayment of its loan in the event that the borrower defaults under its other loans, particularly in respect of payment obligations. The clause seems a reasonable and appropriate one for lenders to include in their loan agreements, since its objective is to provide a deterrent against default by the borrower and to permit lenders to take timely action to protect their loans. Although the cross-default clauses applying to both the Bank and the commercial banks are optional (i.e., the lender has the option whether to exercise its remedies in the event of default by the borrower under its other loans), the Bank’s cross-default clause is project-related (i.e., it relates only to defaults on other loans for the project being cofinanced) while the commercial banks’ cross-default clause frequently relates to defaults by the borrower on any and all of its outstanding indebtedness. Thus, the commercial banks’ cross-default clause is frequently very broad in scope and can be triggered by any lapse in the borrower’s creditworthiness, however brief it may be.
The Bank has agreed to the inclusion of a broader cross-default clause in B-loans in which it has taken a direct financial participation. Where the Bank is a colender in the commercial syndicated loan, the B-loan may be declared in default if the Bank accelerates its parallel A-loan for the project or if the borrower fails to pay material debt service to the Bank or the guarantor under any Bank loan for more than 45 days. The B-loan may not, however, be cross-defaulted to Bank loans in other circumstances. In particular, the Bank has considered developmental covenants, which are an essential feature of the special relationship between the Bank and its borrowers, to be too sensitive a subject to be included in the event of default provision.
In addition to the optional cross-default clause in a B-loan agreement with respect to Bank loans, commercial banks have sometimes requested a mandatory cross-default clause in A-loan agreements. Such a mandatory cross-default clause would legally oblige the Bank to exercise its remedies to suspend, cancel, or accelerate the A-loan (rather than to decide whether it wished to do so) merely on the ground that the commercial bank had decided to exercise similar remedies in respect of the B-loan. The Bank has consistently declined to agree to commercial bankers’ requests to include a mandatory cross-default clause in its loan agreements. It has been a cardinal principle of cofinancing that although the cofinanciers may exchange views and consult with each other concerning their respective loans and the project as whole, this would not in any way limit or impair the independent right of decision and action of each lender under the loan agreement. The principle of “automaticity” that is implicit in the proposal for a mandatory cross-default clause clearly violates this principle.
Subrogation and Indemnity
In cases where the Bank has provided guarantees to the commercial banks in respect of a portion (up to a maximum of 25 percent) of the syndicated B-loan, the Bank, as partial guarantor, unconditionally and irrevocably guarantees to the commercial lenders the due and punctual payment of all amounts of principal up to the guaranteed amount. At the same time, the Bank has, in each case, entered into an indemnity agreement with the borrower under which the borrower agrees to indemnify the Bank immediately in the event that the Bank is called upon to make a payment under the guarantee.
Under the laws of some jurisdictions, it would appear that where a subrogation covenant is not included in the loan agreement, the guarantor may be prevented from exercising rights of subrogation against the borrower until such time as the guaranteed lenders have been repaid in full. However, it also appears that the courts may uphold an express contractual covenant between the guarantor and the lenders stating that the guarantor may exercise its rights of subrogation as soon as they arise (i.e., upon payment under the guarantee) and before the lenders have been repaid in full. Thus, in the B-loan agreement, the Bank has sought the inclusion of a specific provision on subrogation. In addition, the right to immediate indemnification under the indemnity agreement clearly reinforces the Bank’s rights of subrogation in the B-loan transaction.
Sharing of Information: Limitation of World Bank Liability
An issue that has arisen in the context of some B-loan negotiations is the extent to which commercial banks should have access to the Bank’s information concerning the borrowing country. Commercial banks have occasionally sought to obtain an undertaking from the Bank to provide them with information not only with respect to the project and the service of the loan but also with respect to the general financial condition of the borrower.
A clause which would require the Bank to provide unlimited information, particularly about the economic and financial “state of health” of the borrowing country, to commercial bankers would create significant problems for the Bank. In its role and function as the leading multilateral development finance institution, the Bank receives and analyzes a considerable amount of economic and financial information on its borrowers from various other sources, including the borrowers and the International Monetary Fund, frequently under special confidential arrangements. In view of the Bank’s special relationship with its member countries, it is difficult for the Bank to release sensitive information obtained under a relationship of trust without carefully considering the impact on the interests of such member countries.
On the other hand, the Bank is acutely aware that a major inducement to commercial banks to cofinance projects with the Bank is its expertise and knowledge of the borrowing country and the projects appraised. The Bank is also conscious that during the present debt crisis, access to such information is particularly important to commercial banks. Therefore, in cofinancing activities, the Bank has agreed to disclose relevant information on the projects being cofinanced and on general economic conditions in the borrowing country, subject to two important qualifications. First, the Bank has reserved the right to withhold information it considers sensitive or confidential. Second, the Bank has not accepted liability or responsibility for the accuracy of the information provided, except where gross negligence or willful misconduct has been shown. As prudent lenders with independent rights of decision and action, commercial banks are expected to make their own credit investigations and appraisals of each borrower and project before making their loan decisions.
Governing Law and Jurisdiction
Under syndicated loan agreements, provision is generally made for the rights and obligations of the parties to be governed by a particular municipal legal system. On the other hand, the Bank’s General Conditions Applicable to Loan and Guarantee Agreements provide that the rights and obligations of the parties under the Bank’s loan and guarantee agreements “shall be valid and enforceable in accordance with their terms notwithstanding the law of any State or political subdivision thereof, to the contrary.” This provision has been interpreted to mean that the agreements are governed by international law, since the parties thereto are international persons. Disputes under the Bank’s loan and guarantee agreements are to be submitted to arbitration to the exclusion of any other procedure.
In the B-loan agreements, the Bank has accepted the governing law and jurisdiction clauses which are normal in commercially syndicated loans, provided that these clauses protect the rights of the Bank as a colender. As a result, the B-loan agreements are governed by such laws as those of the State of New York, England, or Japan, and the domestic courts of the lenders have jurisdiction to hear and determine any suit, action, or proceeding, and to settle any disputes arising under the agreements. This acceptance by the Bank of such governing laws and forums is one of the significant compromises or accommodations made by the Bank in reaching agreement with the commercial banks on the B-loan program. It has also created an unusual and interesting situation where the relationship between the Bank and its borrowers/guarantors for a cofinanced project may be governed by two separate legal regimes: the first (the A-loan) by international law and arbitration, and the second (the B-loan) by municipal law and the jurisdiction of the courts.
Decision Making
In commercially syndicated loans, decision making on all matters relating to the loan is normally carried out on the basis of “syndicate democracy.” This means that decisions by the syndicate are normally made by a specified majority, with voting based upon amount ofloan commitments (before initial drawdown) and loans outstanding (after initial drawdown). In the case of Bank participation in a B-loan through the direct-funding option, the Bank will only have a minority voice in decision making until most of the commercial portion of the loan has been repaid, at which time the Bank will have a strong voting position. The Bank’s willingness to subject itself to the majority voting provisions of commercially syndicated loans helps make the B-loan program attractive to commercial banks.
When the Bank only guarantees the later maturities of a B-loan which is fully funded by the commercial banks, the Bank obviously cannot exercise any decision making rights, since it is not a lender. However, various provisions in the B-loan agreement usually stipulate that the consent of the Bank as guarantor is required before certain decisions are taken, since these could have implications for the Bank’s position as guarantor.
VI. Recent Developments with Respect to the Heavily Indebted Countries
Search for an International Debt Strategy
The international debt crisis has introduced a complex set of new constraints on the flow of new financing to the HICs. In particular, it has limited the opportunities for cofinancing in many countries, including such large ones as Brazil, Mexico, Argentina, and Nigeria. The two previous speakers have discussed the history of the debt crisis and new proposals for dealing with it. As such, the final section of this paper will concentrate on the roles the Bank might play in facilitating new financing flows to the HICs or in alleviating their excessive debt burdens.
The heavily indebted countries may be broadly divided into two categories: (1) the lower-income, least-developed countries (LDCs), including particularly those in sub-Saharan Africa, and (2) the middle-income countries, such as those in Latin America. Given the very different circumstances, different solutions or approaches are necessary to deal with the problems of these two categories of countries. With respect to the LDCs, the prospects for per capita income growth over the next decade are bleak. Although the absolute amount of their debt is relatively small, their repayment record is poor; their debt-carrying capacity is small; and they can neither gain access to commercial bank loans nor bear their market terms. Accordingly, there is agreement that considerable concessional assistance and quick relief are necessary. In addition to normal debt reschedulings, there have been calls for partial cancellations of debt, substantial reductions or waivers of interest, conversion of loans to grants, and other forms of refinancing. Various official donors’ meetings have been held from time to time to consider the establishment of special funds to help the LDCs get out of their present economic and financial difficulties.
With respect to the middle-income HICs, the strategy followed since late 1985 is that outlined broadly by the Baker initiative. In September 1985, at the Annual Meetings of the World Bank and the International Monetary Fund in Seoul, U.S. Treasury Secretary James A. Baker III unveiled his “Program for Sustained Growth,” now commonly referred to as the Baker initiative. This initiative, which was generally endorsed by the international banking community and the world’s finance ministers, has as its theme the stimulation of growth and adjustment in the HICs and the encouragement of new financing flows from both official and private sources to support this process. The Bank, together with the Fund, is to play a central role in the debt strategy. To support the adoption by the HICs of comprehensive macroeconomic and structural adjustment policies, the Bank and the Inter-American Development Bank were invited to increase annual disbursements to these countries and the international banking community was called upon to provide net new lending of US$20 billion to the middle-income HICs during 1986-88. Official sources, such as the governments of industrialized countries and export credit agencies, were also expected to provide their traditional shares of financing.
The Baker initiative essentially proposed continuation of the case-by-case debt strategy. It recognized that developing countries differ from one another in terms of the progress they have made in implementing policy reforms and adjustment measures, the size of their debt, their new financing needs, and their growth potential. Given such differences, the case-by-case approach was considered preferable to any generalized plan to solve the debt crisis.
Since the announcement of the Baker initiative, there has been a dramatic increase in the share of net flows (i.e., net disbursements) from the Bank and other multilateral financing institutions. During 1985–87, their share of net flows increased to 50 percent of total medium- and long-term flows, compared with roughly 12 percent during 1980–82. In contrast, the relative shares of both bilateral creditors (including export credit agencies) and commercial banks showed marked declines. Net flows from commercial banks have shrunk considerably from an annual average of more than US$12 billion during 1983–84 to less than US$4.0 billion during 1985–87, falling short of the annual target of US$6-7 billion put forward in the Baker initiative. Most of the new lending was concentrated in a few large countries, such as Mexico, Argentina, and Chile.
The recent low levels of lending by the commercial banks give cause for concern about the feasibility of securing adequate net flows from this source in the next few years. The drop in commercial bank lending is due to a variety of factors: increasing skepticism about the prospects for improved creditworthiness in the debtor countries within a realistic time frame, protracted arrears and unilateral moratoriums on debt-service payments by major debtor countries, mounting domestic political difficulties in implementing reforms, intensified regulatory pressures on banks to strengthen their balance sheets, depressed secondary-market prices for developing country debt and its effect on the share prices of major lending banks, and the unpleasant prospect of additional provisioning on both old and new loans. Several banks, particularly the smaller regional banks, which have been badly bitten by their experience with sovereign lending, have also shown a desire to opt out of the new-money process.
As a result of these dilemmas and doubts among the commercial banks, the mechanisms of concerted lending have undergone severe stresses and strains since 1985. For example, during 1986–87, it took almost six months for the Advisory Committee to sell the US$7.45 billion Mexican financial package to the banking community, and more than one year to do the same for a much smaller Nigerian rescheduling and new-money package. Delays have also been experienced with the finalization of new financing packages for Argentina and Ecuador. It is important to realize, therefore, that it is going to be extremely difficult—perhaps impossible—to generate aggregate net flows for the HICs in the required amounts exclusively through concerted lending. Thus, bank advisory committees and borrowers are straining to find and fashion a variety of new techniques and financial instruments to fund adjustment programs and other developmental activities in the HICs.
World Bank Role in Heavily Indebted Countries
The inability of the HICs to secure adequate financing or financial relief from other creditors on a negotiated basis has serious implications for the Bank. It means that the adjustment programs being supported by the Bank will be underfunded, thereby reducing the probabilities of success in restoring growth and development and of a return to commercial credit-worthiness. It also means that the Bank’s own exposure, or total share of debt service, in particular countries will rise over time, thereby making it more difficult for the Bank to continue new lending without undermining its preferred-creditor status. For these reasons, the Bank has a vital interest and responsibility in playing a strong catalytic role by helping the HICs to mobilize much-needed financing from other sources, both official and private. This role has three different dimensions:
Supporting Implementation of Medium-Term Adjustment Programs
By virtue of its long experience as a development lender, its deep knowledge of individual country economic situations, and its technical expertise, the Bank is well equipped to advise and assist the HICs in growing out of their present economic difficulties. The Bank’s primary role is to foster long-term growth and development through structural adjustment programs aimed specifically at increasing domestic resource mobilization; raising the efficiency of resource use in all areas, including the public sector; and expanding net exports. In addition to assisting borrowers in designing such programs, the Bank provides increasing financial support for structural adjustment through fast-disbursing, policy-based loans. It also engages in intensified policy dialogue with member governments to identify needed structural changes and agreement on the required policy reforms. The rationale for this aspect of the Bank’s role is that the resumption of growth in the HICs is an essential condition for their return to creditworthiness and that this resumption of growth depends critically on both domestic policy reforms and the adequacy of external finance.
Catalyzing New-Money Flows
The Bank has made special efforts to inform bilateral lenders and credit insurers of the adjustment programs, prospects, and financing needs of the HICs, and to mobilize resources in support of such programs. It has done this through informal consultations and formal meeting with consultative groups, the Berne Union, and the Paris Club. The export credit agencies have also relied heavily on the Bank’s public investment reviews and project evaluations in making their own lending and credit-insurance decisions. Bank operations, including those of the International Finance Corporation, have also increasingly focused on financial sector reform, legislative reforms designed to encourage foreign direct investment flows, and encouragement of a greater role for the private sector as an engine of future growth—all of which are likely to facilitate the flow of export credit to these countries.
Next week, the Bank is hosting a meeting of the principal export credit agencies to examine new ways of, and approaches to, restoring or increasing export credit flows to the HICs. In the face of reduced cover policies by export credit agencies in certain countries, the meeting will also discuss the possibility of the Bank providing co-guarantees to complement the reduced guarantees of export credit agencies (ECAs) where reduced cover policies apply.
As mentioned earlier, the Export-Import Bank of Japan has set a fine example of cooperation and collaboration with the World Bank in addressing the problems of the HICs by signing a cofinancing framework agreement with the World Bank to provide untied loan funds to cofinance IBRD-supported adjustment programs and investment projects. The “untied” feature of this cofinancing facility is a first among export credit agencies and may be worthy of emulation by other ECAs, at least as a temporary measure to alleviate the problems of the HICs. So far, under this facility, cofinancing operations have been undertaken in several countries, including Mexico, Indonesia, Argentina, the Philippines, and Turkey; and more are under consideration.
Another development worth mentioning is a special cofinancing grant facility established by the Government of Japan and the World Bank in June 1987. Under this facility, 30 billion yen in grant funds has been committed over three years to cofinance IBRD-supported sectoral and structural adjustment operations, rehabilitation projects, technical assistance, and emergency assistance provided to countries experiencing natural disasters or severe economic turmoil.
It may also be worth mentioning that in early 1985, the Bank and 14 Part I (industrialized) countries established the Special Facility for Sub-Saharan Africa. Under this facility, the Bank and the 14 countries agreed to mobilize additional resources of over US$1.1 billion to be committed during 1985–87 to support policy reform in IDA-eligible countries in sub-Saharan Africa. In addition, the Special Facility for Sub-Saharan Africa provided for the making of additional financial contributions by other countries through special joint financing operations. Credits provided under the facility have so far been used primarily to finance quick-disbursing structural and sectoral adjustment programs, and rehabilitation programs with a major policy content. The Special Facility for Sub-Saharan Africa was conceived as an effective catalyst providing urgently needed funds for initiating policy reforms and economic development in the poorest countries of Africa. Its resources are by no means sufficient to meet the external capital requirements of sub-Saharan Africa, but its creation marks an important beginning and sets a useful precedent. Further proposals along these lines are under consideration in different official forums, and the Bank is actively participating in these discussions.
The most difficult part of the Bank’s catalytic role concerns the mobilization of resources from commercial banks. I have discussed the reasons for the slowdown in commercial bank lending earlier in this paper. A number of principles influence the Bank’s catalytic role in the concerted lending process. First, the financing plan for the debtor must be based on an adjustment program that is well designed and realistically funded. Second, the commercial bank financing package must reflect appropriate burden sharing among the principal creditors. This is extremely important, because the Bank’s exposure in several of these countries has become disproportionately high in relation to that of the commercial banks. Third, any credit enhancement of new commercial bank financing packages becomes part of the Bank’s share of incremental exposure and, as such, should be provided on an extremely selective basis. Finally, the Bank’s role is to facilitate negotiated settlements. Thus, the Bank should provide credit enhancement only when its presence is critical to the finalizing of negotiations on a financing package.
So far, the Bank has played its catalytic role on a case-by-case basis, guided by the principles outlined above. This catalytic role has taken one or both of the following forms: (1) formal linkages between its own lending operations and a commercial bank financing package, and/or (2) provision of specific credit enhancement, through guarantees, of selected portions of some commercial bank financing packages.
Linkages have generally been of four different types:
(1) Issuance of statements by the borrower or the bank. The statements may cover such matters as confirmation of the borrower’s continued eligibility to draw down Bank loans and of net resource transfers from the Bank to the borrower. Such statements may be required by the commercial bank lenders as a condition for triggering actions (e.g., release of tranches, effectiveness of refinancings) under their agreements.
(2) Linkage to disbursements and other operational program “milestones.” In some cofinancings, such as that associated with the US$7.45 billion Mexican financing package, the commercial banks phased the drawdowns of their loans to coincide with the progress achieved by the borrower under its medium-term structural adjustment program, as reflected in part by implementation of the Bank’s and the Fund’s respective operational programs for the country as scheduled. Thus, drawdowns of successive tranches of the commercial loan may be conditioned upon events such as release of tranches under the Bank’s structural adjustment loans, approvals of new sectoral and policy loans, and the effectiveness of such loans.
(3) Information sharing and notification provisions. In most cofinancings, the Bank agrees to share with the commercial banks non-confidential information on the status of the cofinanced loan, the borrower’s eligibility to draw down Bank loans generally, and other relevant information related to the cofinancing.
(4) Optional cross-default clause. Optional cross-default clauses incorporated in the Bank’s own loan agreement for the cofinanced loan entitle the Bank to exercise remedies (such as suspension, termination, and acceleration) against the borrower when the parallel commercial loan has been suspended, terminated, or accelerated. Commercial bank lenders also incorporate optional cross-default clauses (which were described earlier in this paper) in their loan agreements with respect to Bank loans. Such linkages have proved useful in facilitating recent new-money negotiations for such countries as Mexico, Argentina, Chile, Nigeria, and Côte d’Ivoire.
Credit enhancement can be provided either through partial guarantees of a portion of a commercially syndicated loan or by taking a direct financial participation in such a loan. Here it is important to note that the B-loan instruments approved by the Bank in 1983 were designed primarily to increase the DMCs’ access to the commercial markets by elevating the status and quality of B-loans through association with the Bank. They were also designed to extend the maturities of commercial loans to lengths more appropriate for development investments. Use of the B-loan instruments in the HICs was not originally envisaged. Nevertheless, since 1985, commercial banks’ advisory committees have been pressing the Bank to provide credit enhancement on new-money loans made in conjunction with rescheduling exercises. The risk-management consequences for the Bank under the two alternatives—direct financial participation and guarantee—are different. Under the direct financial participation option, the Bank is required to immediately assume incremental exposure in a borrowing country where it may already have a large exposure. Additionally, the Bank is placed in essentially the same position as the commercial banks with respect to all cash flows associated with the loan. The presence of payment-sharing provisions in commercial bank loan agreements in which the Bank takes a direct funding participation means that in order for the Bank to be paid on interest or principal, the commercial bank lenders must also be paid on their own similar claims, thus elevating the entire loan to preferred-creditor status. This is why the Bank has so far resisted taking direct funding participation in commercial bank loans to the HICs.
On the other hand, under the guarantee option, the Bank does not accept a role equal to that of the commercial banks. The Bank’s exposure is clearly separable, and it has taken the firm position that it will not agree to subordinate its own claims on the borrower (i.e., in the event of a payment made under its guarantee) to claims of the commercial banks. This principle of nonsubordination is reflected in the subrogation clauses included in commercial bank loan agreements in which the Bank is a partial guarantor. Guarantees have been the preferred instrument where the Bank has agreed to provide credit enhancement for loans to the HICs. Non-accelerable guarantees of late maturities, in particular, have been preferred because of their low costs to the Bank in near-term country exposure.
In all, the Bank has provided catalytic support to commercial banks’ agreements with the HICs in nine instances. Guarantees have been provided in three cases: Chile in 1985, Uruguay in 1986, and Mexico in 1987. In the other cases, the Bank has agreed to various linkages (as discussed above) between the commercial bank loan agreements and Bank operations.
The Bank has become increasingly aware, as have the commercial banks, that if new financing flows to the HICs are to be increased, as called for under the Baker initiative, the search for new financing instruments and techniques must be intensified. In recognition of this need, the Bank, as part of its reorganization last year, established a new Debt Management and Financial Advisory Services Department to work full time in this area. Staff of this new department—together with their counterparts in the country departments, the Legal Department, and the Cofinancing Department—are working closely with each other and with the commercial banks and the HICs to examine the feasibility of using various new financing instruments and techniques for future new-money packages and also studying potential Bank roles in implementing such new ideas. Examples of some of the techniques under study are the following:
(1) New-money bonds. These bonds would be issued to banks in conjunction with their participation in new-money agreements. This was tried for the new-money package put together for Argentina in 1987. In view of their greater tradability and perceived seniority, these bonds could be useful to banks seeking to manage their exposure to particular countries.
(2) Convertible bonds. These bonds would carry Warrants to allow their conversion to specific equity issues in public companies. Such a bond issue could be offered in the context of a privatization program.
(3) Interest capitalization. Although somewhat controversial, this involves raising new money through the capitalization of a portion of interest due. The main attraction of this technique is that it automatically enforces burden sharing.
(4) Contingent lending. This enables adjustment financing packages to be partly dependent on the outcome of economic events over which the borrower may have little control and which may affect its financing requirements. This technique was used in the 1987 Mexican new-money package, which included two contingent loan facilities whose release was to be triggered in the first case by foreign exchange problems arising from a decline in the price of oil and in the second case by a drop in the country’s growth rates.
(5) Interest rate hedging. Since much of the commercial bank debt to the HICs continues to be on a floating-r ate basis, with interest rate in creases posing a serious threat to the debt-servicing capacity of borrowers, interest rate swaps have been proposed as a way of reducing such risks.
(6) Commodity-linked bonds. These bonds would link debt service to the prices of exported commodities, thereby reducing the risk of foreign exchange shortages preventing the servicing of external debt.
Under some or all of the above new techniques, there might well be a potential role for the Bank to play in facilitating the implementation of such techniques. This role can vary from establishing linkages between the use of such techniques and Bank operations and using optional cross-default clauses, on the one hand, to the Bank assuming some form of administrative or agency role and, in selected cases, providing some form of credit enhancement through partial guarantees, on the other hand. The Bank’s role must of necessity be determined on a case-by-case basis, having due regard to various factors, such as country-specific considerations, including the Bank’s country assistance strategy for each borrower; coun try exposure considerations; limitations placed on the Bank by its Articles of Agreement or local laws affecting its ability to assume specific roles; possible legal liabilities which the Bank might assume under different roles; implications for the Bank’s prime standing in the capital markets where it is a major borrower; and, of course, the Bank’s overall policies. Finally, any credit enhancement which the Bank provides must be used to facilitate market-oriented solutions.
Facilitating Debt-Conversion and Debt-Reduction Schemes
To date, the Bank’s involvement in the concerted lending process has consisted primarily of providing catalytic support for new money. However, over the past couple of years, increasing discussion has taken place on the use of various techniques to reduce the HICs’ outstanding debt. Two principal factors have given rise to this growing interest in debt-reduction techniques. First, HIC debt has been trading for some time now in the secondary market at substantial discounts. In spite of legal hurdles posed by old commercial bank loan agreements, HIC borrowers are most anxious to find ways to obtain such discounts themselves so as to retire part of their debts. Second, the markets have gradually come to accept the view that the HICs need financial relief in order to grow and that such relief can best be provided through a consensual, negotiated approach rather than by a unilateral resort to arrears. With the increasing loan-loss provisions made by commercial banks in the past year, there is growing recognition of the importance of ensuring that losses taken by the commercial banks are translated into debt relief for the country in a way that restores its creditworthiness and, eventually, its normal access to private financial markets.
Debt-reduction techniques, on the other hand, do present dilemmas for both the HICs and the banks, since such techniques tend to be in conflict with the objective of obtaining new money from the same institutions that would be taking losses in the debt reduction. Furthermore, no consensus has emerged on the use of debt-reduction techniques. Yet there appears to be growing acceptance of the view that debt-reduction techniques do have a place in the “menu” of options available to resolve the debt crisis, since they directly address the problem of an excessive debt overhang.
There are basically three types of debt-reduction techniques:
(1) Debt-equity conversions. This has been the most successful tech nique used so far. In such a transaction, an investor purchases debt denominated in foreign exchange from a commercial bank (usually through an intermediary) at a discount. The investor then converts the debt into its local-currency equivalent (less any fees or commissions levied by the debtor government) and uses the proceeds to obtain equity in an enterprise in the debtor country. Debt-conversion programs are now in place in such countries as Chile, Mexico, Argentina, the Philippines, and Brazil, and are under active consideration in other countries.
(2) Exchange offers. This involves the substitution of repackaged obligations or more tradable financial instruments for old commercial debt obligations. Because the old debt is trading at a discount, the exchange would involve either some discount from the face value of the old debt or a reduction in the interest rate and possibly some form of collateralization of the new obligations. Early this year, Mexico successfully undertook an exchange offer of the first type which was collateralized by U.S. Treasury securities.
(3) Debt buybacks. This involves the debtor purchasing (and thus retiring) its debt obligations for cash at a substantial discount from their face value. It is distinguishable from debt conversions and exchange offers in that it involves a straightforward extinguishment of debt, rather than a conversion of one form of obligation to another. Bolivia has recently undertaken such an operation.
As with the catalyzing of new money, the Bank may be called upon to facilitate negotiated agreements between a debtor and its creditors in order to implement particular debt-reduction schemes. Additionally, other issues arise, such as whether Bank loan funds could be used to finance debt buybacks or debt-conversion programs, or whether Bank securities could be used as collateral for an exchange offer. In the recent Mexican collat-eralized exchange offer, the Bank was asked to, and did, waive the negative pledge restriction under its loan agreements with Mexico in order to allow the transaction to proceed. Under the Bank’s Articles of Agreement, it would be difficult for the Bank to justify intervening in a proposed debt-reduction scheme solely on the ground that this would reduce the debt burden of the country concerned. In order for the Bank’s intervention to be justified, such action would have to fulfill the purposes of the Bank—that is, the scheme would have to free up resources that would otherwise have been allocated to debt service for specific productive purposes or otherwise facilitate or enhance investment in the country.
Apart from debt conversions, there has not been much experience gained in undertaking debt buybacks and exchange offers. Given that the Bank’s primary role in the HICs is to catalyze new money, it needs to proceed cautiously with respect to debt-reduction schemes. In countries where new money is not forthcoming despite the Bank’s efforts, debt reduction might prove a useful way of easing their debt burdens without compromising other objectives. This is an area in transition, and the Bank needs to respond to each proposed new scheme on a case-by-case basis.
VII. Conclusion
Over the last five years, the Bank has responded to the slowdown in financing flows to the DMCs by initiating or supporting various measures designed to revive and increase such flows.
In the area of cofinancing, the Bank has been able to mobilize a substantial amount of resources for development in the DMCs and to provide new or enlarged access to the private capital markets for several of the less creditworthy DMCs. The B-loan instruments have also enabled DMCs to obtain better terms on their borrowings.
Faced with a growing debt crisis and lower-than-expected growth rates in the HICs, the Bank is being increasingly called upon to play a leadership role in resolving the crisis and in facilitating new financing flows to the HICs. The Bank is an economic development agency and not a debt-management agency, but it is clear that the continuation of a debt crisis of the present magnitude would be a serious obstacle to growth and economic development in the HICs. Thus, the Bank finds itself thrust into an unexpected and difficult role and has to address and deal with a number of new and interesting issues concerning the specific roles it can and should play in this crisis. The Bank’s overriding concern is to do everything possible to ensure that the HICs receive adequate new financing to fund their adjustment programs and fuel their growth.
The search for new and imaginative solutions to the debt crisis has placed a heavy responsibility on the shoulders of lawyers working for the Bank, the borrowing countries, and the commercial banks. They will need to address a variety of difficult legal issues and to find and fashion new legal techniques and instruments for use in international financing. Much of the territory that has been covered in this paper is a no-man’s-land where few or no legal precedents are available to serve as guideposts. As several of the proposals currently under discussion test the frontiers of traditional legal practice, the subjects discussed in this paper promise to offer continuing stimulation and challenge in the next few years.