Countries, like individuals, may run up debt and find themselves unable to keep up the payments on it. To avoid defaulting, they must restructure their debt. But, unlike bankruptcy provisions in domestic situations, the global financial system lacks a legal framework for sovereign debtors and their creditors to restructure debt in an orderly and timely way. One major challenge to sovereign debt restructuring stems from the way international capital markets have evolved over the past 20 years or so. They have become more integrated and there has been a shift from syndicated bank loans to bond issues. As a result, sovereign borrowers are increasingly able to issue debt in a range of legal jurisdictions, using a variety of instruments, to a diverse and diffuse group of creditors. Although this has expanded the sources of financing available to emerging market countries, it has also exacerbated the problems of coordination, collective action, and equal treatment of creditors when a restructuring becomes necessary.
IMF proposes a solution
In November 2001, IMF First Deputy Managing Director Anne Krueger proposed a sovereign debt restructuring mechanism (SDRM) to facilitate the orderly, predictable, and rapid restructuring of unsustainable sovereign debt. Since November, the proposal has undergone various changes, and the IMF’s decision-making role is envisaged to be smaller in the latest incarnation. The resulting twin-track—that is, statutory and contractual—approach has since received the endorsement of the international community.
For the mechanism to be effective, there must be incentives both for debtors to address their problems promptly and for debtors and creditors to agree quickly on the restructuring terms. The IMF’s policies spelling out the availability of its resources before, during, and after the restructuring process would help shape these incentives. However, use of the mechanism would be for the debtor country to decide and not for the IMF or a country’s creditors to impose. The debtor country and a majority of its creditors would have the essential decision-making authority.
How the mechanism would work
The first track of the SDRM would involve greater use of collective action clauses in sovereign bond contracts. The second track would involve creating a statutory mechanism to empower a qualified majority of a country’s creditors to negotiate a restructuring agreement that would then be binding on all of the country’s creditors. There would also be provisions to prevent creditors from pursuing litigation against debtors while a restructuring agreement is being negotiated; safeguards to protect creditor interests during this period; and a mechanism that would encourage new financing by guaranteeing that fresh private lending would not be restructured. The statutory approach would use a treaty obligation—probably achieved through an amendment of the IMF’s Articles of Agreement—that would provide for legal uniformity in all jurisdictions.
To coordinate a debtor’s varied creditors, a framework must be created that will aggregate claims across instruments for voting purposes while taking account of the seniority and varying economic interests of the creditors. As part of this framework, a forum is envisaged for the resolution of disputes between a sovereign debtor and its creditors as well as disputes among creditors. The dispute resolution forum would be small, have a limited role, and be independent in its membership and operation.
The international community has learned its lesson from the turmoil that emerging market economies have experienced in recent years: cooperation helps the global financial system work more smoothly. To address the protracted, disorderly, and costly restructuring process, the IMF will continue to examine the legal, institutional, and procedural aspects of establishing the sovereign debt restructuring mechanism.
For a fuller explanation of the proposed SDRM, see the IMF’s website (http://www.imf.org).