- Anne Krueger
- Published Date:
- April 2002
The absence of a robust legal framework for sovereign debt restructuring generates important costs. Sovereigns with unsustainable debts often wait too long before they seek a restructuring, leaving both their citizens and their creditors worse off. And when sovereigns finally do opt for restructuring, the process is more protracted than it needs to be and less predictable than creditors would like.
The international financial system lacks an established framework for restructuring that is equitable across all of the sovereign’s creditors. There are few effective tools to address potential collective action problems that threaten to undermine restructuring agreements acceptable to the debtor and most of its creditors. Holdout creditors may be able to use the threat of litigation to seek to avoid concessions that the majority have agreed to make.
All this explains why it is important for the official community, sovereign debtors, and market participants to discuss how to improve the sovereign debt restructuring process.
This paper has laid out a possible approach. An international legal framework could be created to allow a qualified majority of the sovereign’s creditors to approve a restructuring agreement, and to make that decision of the majority binding on a minority. The vote would need to include all the relevant creditors of the sovereign, not just the holders of a single debt instrument. Broadening the majority voting process beyond a single debt instrument vastly simplifies the process of creditor coordination, and would facilitate the negotiation of a deal that treats all creditors fairly. This approach draws on the principles of well-designed corporate bankruptcy regimes, and is similar in concept to the decision-making procedures among holders of a single bond issue that contains a majority restructuring clause.
Provisions for majority action would be most effective if supported by three other features, all of which protect the debtor’s assets and capacity to pay while it works with its creditors to reach an agreement. The features are: a stay on creditor litigation after the suspension of payments; mechanisms that protect creditor interests during the stay; and the provision of seniority for fresh financing by private creditors. A single body would need to oversee the process of verifying claims and to resolve any disputes.
In such a framework, the decision whether to give legal protection for the sovereign and provide seniority for new private financing could to be left to the debtor and a qualified majority of its creditors. Similarly, the sovereign and a qualified majority of creditors would agree on the the terms of the ultimate restructuring. The primary purpose of an amendment of the IMF’s Articles would be to provide the statutory legal basis to make an agreement between the debtor and the requisite majority of creditors binding on all relevant creditors.
There are a number of questions that would need to be fleshed out before such an approach could be made operational. Perhaps most crucial, and also most difficult, is the scope of the debt to be included in the voting process. It will also be important to explore with debtors and market participants how best to protect general creditor interests during the negotiating process, as well as how to structure the dispute resolution process.
These questions will not be easy to answer. But it is important not to shy away from the challenge. There is now widespread agreement that a new approach is necessary, and that a fairer, more efficient process for sovereign debt restructurings would represent a substantial strengthening of the international financial system. We should press ahead to achieve it.