Annex 1 Argentina—The Process Toward Sovereign Debt Restructuring
Background: In the fall of 2001 and amidst a deepening economic crisis, the authorities considered a strategy based on the comprehensive restructuring of its roughly US$100 billion of domestic and external debt owed to private creditors. To mitigate risks of unsettling the stability of the domestic financial system, the authorities announced a two-phase approach in late October 2001. Phase 1 was aimed at domestic resident investors and was completed in December 2001. Before the second phase could be initiated to restructure the roughly US$50 billion of mainly foreign-held sovereign debt, the financial and political situation deteriorated considerably. Argentina announced a moratorium on payments to non-Phase 1 private debt in late-December 2001. Argentina also suspended payments on its US$4.5 billion debt to official bilateral creditors (of which, US$1.8 billion is owed to Paris Club creditors). Despite occasional delays, Argentina has remained current on its obligations to multilateral financial institutions.
Authorities’ strategy: Efforts to lay out a debt restructuring strategy were complicated in 2002 by the significant uncertainty regarding Argentina’s macroeconomic environment and the authorities’ policy framework. Against difficulties in securing political consensus on a program that could lay the basis for debt negotiations, the authorities’ dialogue with creditors remained limited. The implementation of a stabilization program in early 2003 helped abate economic pressures and restore a measure of economic stability. Following the presidential elections in the spring of 2003, the debt strategy of the new administration evolved into a two track approach. First, to develop a medium-term macroeconomic framework to help form the basis of an economic program that can be supported by the Fund and other multilateral institutions, and define the broader envelope of resources available for debt-service, in line with debt sustainability requirements. Second, with the assistance of external advisors, develop procedures to consult with creditors, in preparation for a debt restructuring offer. As part of this strategy, the authorities indicated that they hope to announce the outline of a restructuring proposal by the time of the 2003 Annual Meetings.
Dialogue with creditors. Several meetings with creditors were conducted in the United States, Europe, and Japan in late 2002 and early 2003. Most creditors expressed disappointment that the dialogue lacked substance although some creditors expressed understanding on the grounds that the authorities were not able to make credible commitments regarding the debt restructuring prior to the May 2003 presidential elections. In meetings with creditors held in Paris, London, Zurich and Frankfurt in June 2003, the authorities announced their intention to form creditor consultative groups to share information and better understand investors’ needs and expectations. These groups are intended to reflect the structure and geographical distribution of Argentina’s international bonded debt. In particular, three regional groups represent retail investors in Germany, Italy, and Japan, and one global group based in New York represents institutional investors. The authorities expect eventually to coalesce these groups into a single global consultative group. Membership was decided by the authorities, based on a number of criteria, including a member’s representativeness of a particular investor base and potential to contribute to a constructive dialogue. The authorities intend to engage these groups in successive rounds of meetings, starting in late-July, at which the broad parameters of a medium-term framework would be presented, issues regarding the debt coverage as well as the treatment of various forms of debt will be clarified, and creditors’ views regarding the design of debt instruments will be sought. The main points of the meetings with the consultative groups will be made available to all bondholders via press releases. Creditors’ views have so far been muted on the formation of regional creditor groups. While some creditors have expressed a preference for negotiations to be conducted within a formal creditor committee framework, others considered that the formation of representative negotiating committees would not be practical given the size and diversity of bondholders.
Creditor coordination. In the 18 months that have lapsed since the default, institutional investors and retail bondholders have made only modest progress in coordinating their actions. To some extent this may reflect the vast number of creditors (it is estimated that 400,000 retail investors hold half of the defaulted debt) and the diversity of interests, but also the fact that serious negotiations have not yet begun. The most significant creditor coordination actions to date include the establishment of a committee of institutional bondholders in the US in early 2002, and more recently, the formation of an association by Italian banks to represent retail investors and the formation of a special purpose vehicle (ABRA) to coordinate representation for other European retail bondholders which is backed by a group of European banks and investment funds. The authorities have welcomed these efforts and expressed their intention to work with all creditor groups and initiatives, without discriminating against any creditor. In this context, they announced that they would not reimburse fees associated with legal or financial advisors retained by these committees.
Paris Club bilateral creditors have had a number of discussions with the Argentine authorities. The participating creditor countries have also agreed, in principle, to a meeting to consider Argentina’s debt in due time. So far, there has been limited dialogue between private creditors and official bilateral creditors.
Creditors’ legal actions. Although most creditors seem prepared to wait for the authorities to initiate the process of debt restructuring, a number of lawsuits have been filed in New York and in Europe. These include two class action suits filed in New York, which, however, were dismissed on the grounds that the classes were amorphous and ill-defined. Argentina has had mixed success in defending other cases filed and some litigating creditors have succeeded in obtaining court judgments.
Annex 2 The Uruguay Debt Restructuring
Background: In the aftermath of a severe currency and banking crisis in the summer of 2002, partly the result of contagion from neighboring Argentina, the authorities were confronted with acute debt problems. Uruguay’s total debt had escalated to about 100 percent of GDP, or roughly US$ 11 billion, with significant debt-service obligations falling due in 2003 and 2004. To alleviate the cash flow pressures and help restore debt sustainability, the authorities embarked on a voluntary debt exchange aiming at lengthening the average maturity on the market private debt. With the assistance of financial and legal advisors and in the context of the Fund-supported program, the authorities prepared a first draft of a plan in October 2002 but considered it insufficient to address the underlying problems. The stabilization the banking system over the last months of 2002 delayed the preparation of a revised plan. This was completed in February 2003 after a renewed bank run and further loss of reserves in late January/early February and fears of a pending default. On the basis of the revised plan the authorities proceeded to engage creditors in a dialogue over the debt restructuring. The debt restructuring involved essentially three components: an external component, covering mainly those bonds issued in Europe and the US (all without collective action clauses, amounting some US$ 3.6 billion), a domestic component, covering bonds issued in the domestic market (some US$ 1.6 billion), and a Japanese component, covering Uruguay’s Samurai bonds (US$ 250 million, containing collective action clauses). Following a period of informal dialogue with creditors, the authorities launched the exchange on April 10 and completed it on May 29 after a brief extension period.
Authorities’ strategy: A primary consideration for the authorities was to avoid default. In this context their strategy aimed at a collaborative process and a voluntary exchange. Since time was of the essence, the authorities relied on informal contacts with creditors. As near-term debt-service relief was a major consideration, bondholders were offered to swap existing bonds for new longer maturity instruments with broadly the same face value and coupons as the old bonds, implying a NPV reduction. To encourage high participation rates, the authorities established a commitment to complete the offer if participation exceeded 90 percent, maintaining discretion if participation levels fell between 80 and 90 percent. They also announced that the exchange would not go ahead if participation fell below 80 percent.
Creditor coordination. Given the time constraint for the completion of the restructuring, inter-creditor coordination was limited. Generally, no serious inter-creditor equity issues were raised, particularly since the debt exchange involved nearly all of Uruguay’s market debt, and the design of the final plan took into account investors’ concerns. Additionally, Uruguay’s official bilateral debt was very small, implying that its exclusion from the exchange was not perceived to be a problem by affected creditors.
Dialogue with creditors. The authorities actively sought to involve bondholders in an informal consultation process. The dialogue was guided by the premise that the authorities wished to resolve the debt situation in a voluntary and collaborative manner. The authorities held a first round of meetings (in the United States, Europe, Japan, and Uruguay) to explain their current situation and have the creditors’ input on the debt restructuring offer. On the domestic front, the authorities maintained contacts with major institutional investors. Since domestic market participants had been exposed to the effects of the 2002 financial crisis, they were generally receptive to the proposed plans. Benefiting from creditors’ input in this first round of talks, the authorities formally launched the exchange offer on April 10, 2003, which was to remain open until May 15. They then proceeded to a second round of meetings with investors, this time to explain the main features of the proposal and its consistency with the envisaged macroeconomic adjustment and financing envelope. The authorities published the Staff Report for the Second Review, to provide further information to the public on their economic and financial program. They also stepped up their communication efforts through interviews and advertisements in the local media while remaining in close contact with key investors and analysts.
Special features of the new bonds. The new foreign-law bonds include collective action clauses enabling Uruguay to change the payment terms of each series of bonds with the consent of investors representing 75 percent of outstanding principal of the specific series. Additionally, the new bonds also include an “aggregation clause” allowing Uruguay to change the payment terms in more than one series of bonds with the consent of investors representing only two thirds of outstanding principal of each affected series, as long as there is also agreement by at least 85 percent of aggregate bondholders affected by the change.
Strategy to deal with the holdouts. The authorities explicitly warned that, if unable to meet all debt-service obligations, they would service the new debt in preference to the old. In addition, they used legal and regulatory incentives to deter non-participation. Holders exchanging the external bonds were asked to approve exit consents, which would reduce the ability of holders of the old bonds to enforce debt-service payments. On the domestic component, the authorities established that the old bonds would: (i) require a 100 percent risk weight for banks’ computation of risk-adjusted capital ratios; (ii) need to be marked-to-market; (iii) be delisted from the stock exchange; and (iv) not be acceptable as collateral for liquidity assistance from the central bank. On the Japanese component, the authorities and advisors relied on the activation of collective action clauses at a bondholders’ meeting, requiring a quorum of bondholders with 50 percent of outstanding principal, with a favorable vote of more than 2/3 of the principal represented at the meeting.
Results. After a short extension, the offer finally closed on May 29, achieving participation rates of nearly 99 percent on the domestic component, some 90 percent on the external, and 100 percent on the Japanese component. Overall, participation rates reached an average of about 93 percent, with participation on bonds maturing in 2003 and 2004 reaching about 95 percent. Several factors may have contributed to the success of the exchange: (i) realization by investors that Uruguay’s debt and external position were not manageable without the exchange—buttressed by effective Fund conditionality which clearly conditioned further disbursements on satisfactory financing assurances; (ii) a well-designed exchange offer, acceptable to a wide range of investors while meeting financing constraints, and marketed effectively (particularly by domestic retail intermediaries) in a cooperative approach; (iii) relative attractiveness of the new bonds (greater liquidity) versus the old ones (exit consents, worse regulatory treatment); (iv) the relatively modest size of the haircut (around 20 percent); (v) the general rally in emerging market debt during the exchange period; and (vi) Relatively high prices on the old bonds initially (trading at an average of around 50 cents on the dollar prior to the announcement of the exchange) may have reduced incentives to holdout as the potential upside was limited in the event of recovery of the old bond, either through litigation or because the old bonds were repaid, while the downside was substantial in the event the exchange were to fail and default were to materialize.
Annex 3 Treatment of Debt Restructurings by Credit Rating Agencies
The recent IMFC communiqué stated that: “The Committee, while recognizing that it is not feasible now to move forward to establish the SDRM, agrees that work should continue on issues raised in its development that are of general relevance to the orderly resolution of financial crises. These issues include inter-creditor equity considerations, enhancing transparency and disclosure, and aggregation issues.”
See “Crisis Resolution in the Context of Sovereign Debt Restructuring—A Summary of Considerations,” SM/03/40, January 29, 2003 and “Sovereign Debt Restructuring and the Domestic Economy: Experience in Four Recent Cases,” SM/02/67, February 21, 2002.
Preliminary considerations regarding a Code of Conduct are laid out in “Proposed Features of a Sovereign Debt Restructuring Mechanism”, SM/03/67, February 12, 2003.
Henceforth, the term pre-default will be used to indicate circumstances where restructurings were used to avoid payment default.
The Ukraine restructuring was initiated pre-default. However, the grace periods for the payment default under two of Ukraine’s bonds expired while the exchange offer was still open. From that point on and until completion of the exchange, Ukraine was in default.
For instance, Uruguay completed its debt exchange in only a few months from the date of announcement of the restructuring, while Ecuador’s restructuring took more than 10 months from the date of default (Argentina is 18 months and counting). There have also been large variations in the ownership of the debt being restructured along several dimensions: (i) a predominance of retail investors (Ukraine) versus significant holdings by large institutional investors (Ecuador); (ii) large exposure of residents or domestic banks (Argentina) versus exposure by non-residents (Ecuador, Moldova); and (iii) cases where sizeable claims were held by official bilateral creditors (Pakistan) versus cases where debt was primarily in private hands (Uruguay).
Indeed, the fiscal costs of resolving underlying financial and corporate sector difficulties may not be known for a while. The impact on banks’ balance sheets may be significant but difficult to quantify in situations of stress, partly because this will be highly dependent on the particular actions taken, and partly because the repercussions on asset quality and bank equity may take time to materialize. See “A Framework for Managing Systemic Banking Crises”, SM/03/50, February 6, 2003. See also “Crisis Resolution in the Context of Sovereign Debt Restructuring – A Summary of Considerations”, SM/03/40 (January 29, 2003) for a fuller discussion of the interaction between a country’s economic policies and the debt restructuring process.
The Fund can publish staff reports related to a member’s economy only with the approval of the member in question. Despite significant progress, the publication practice is not yet universal. Slightly over half of all stand alone staff reports for use of Fund resources are published, while some 90 percent of LOIs/MEFPs are published. See “The Fund’s Transparency Policy – Issues and Next Steps”, SM/03/200, June 5, 2003. Letters of Intent may be published by the member itself in advance of Board meetings, as these are documents of the authorities, but this is rare. The Fund does not post Letters of Intent or Memoranda of Economic Policies on its website until after they have been discussed by the Board. In practice, therefore, there can be a considerable hiatus between the moment a restructuring decision is announced and the disclosure of the details of the economic program that is supported by a Fund arrangement.
In the majority of cases (Moldova, Pakistan, Ukraine, Uruguay, Russia, and Argentina), a Fund arrangement was in place at the time the restructuring decision was announced, although some programs had slipped off track. In the case of Ecuador an arrangement was approved two months prior to the launch of the exchange offer.
The Agreed Minute, which lays out the restructuring terms between the debtor and Paris Club creditors, is currently not published. A detailed treatment of Paris Club operations and its comparability of treatment principles is contained in “Involving the Private Sector in the Resolution of Financial Crises – The Treatment of the Claims of Private Sector and Paris Club Creditors – Preliminary Considerations”, EBS/01/100, June 27, 2001.
The good faith criterion in the Fund’s Lending into Arrears policy includes disclosure and transparency requirements for information needed to enable creditors to make informed decisions on the terms of a restructuring. See “Fund Policy on Lending into Arrears to Private Creditors – Further Considerations of the Good Faith Criterion” (SM/02/248, July 31, 2003, and BUFF/02/142).
The impact on bank balance sheets may be significant but difficult to quantify in situations of stress, partly because the repercussions on asset quality and bank equity may take time to materialize.
An alternative means of enhancing information exchange has been proposed through use of contractual covenants in bonds. Varying degrees of such covenants have been proposed by the G10 Working Group on Contractual Clauses and by certain financial industry associations. See “Collective Action Clauses – Recent Developments and Issues”, SM/03/102 (03/25/03) and the Summing Up (BUFF/03/25). Notably, the new bonds issued as a result of Uruguay’s recent debt exchange include a contractual commitment that Uruguay will provide certain information to investors (including any applicable stand-by or extended arrangement from the Fund, letters of intent and memorandum of economic policies) before any future modification of the bonds is sought.
Staff’s presentation at the meeting of Ecuador’s bondholders in May 2000 was immediately published on EMCA’s website. The Fund has also recently developed guidelines for the content, review and circulation of assessment (“comfort”) letters or statements. In principle such letters could, with the consent of the member, be used to inform private creditors of the member’s macroeconomic conditions and prospects, as well as relations with the Fund. See “Operational Guidance Note for Staff on Letters and Statements Assessing Members’ Economic Conditions and Policies”, SM/03/216, June 20, 2003.
In some circumstances, securities regulations could constrain the types of information that a sovereign can release to the market prior to an offering of securities. For example, Section 5 of the U.S. Securities Act of 1933 prohibits “conditioning the market” through selling or offering to sell securities in a public offering in the United States before a registration statement has been filed with the U.S. Securities and Exchange Commission (SEC). In the recent case of Uruguay, the proposed scope of the debt exchange was only disclosed after the filing of relevant documentation with the SEC, because of “conditioning the market” concerns. Also, in the Ecuador restructuring, Ecuador’s representatives argued that they were prevented from providing information on the proposed exchange prior to filing with the SEC.
Uruguay’s recent debt exchange illustrates that informal consultations can be effective, even in cases with a large retail investor base. Several factors may have been critical to the success of Uruguay’s pre-emptive exchange offer: (i) a realization by investors that Uruguay’s debt and external position were not manageable without the exchange – buttressed by effective Fund conditionality which conditioned further disbursements on satisfactory financing assurances; (ii) a well-designed exchange offer, acceptable to a wide range of investors while meeting financing constraints, and marketed effectively (particularly by domestic retail intermediaries) in a cooperative approach; (iii) the relative attractiveness of the new bonds (greater liquidity) versus the old ones (exit consents, worse regulatory treatment); (iv) the relatively modest change in the financial terms of the bonds (maturity extension at the existing coupon); and (i) the general rally in emerging market debt during the exchange period.
A comprehensive earlier discussion of the role of creditor committees is contained in “Involving the Private Sector in Forestalling and Resolving Financial Crises – the Role of Creditor’ Committees – Preliminary Considerations” (SM/99/206).
A detailed treatment of the involvement of Paris Club creditors in the resolution of financial crises is contained in “Involving the Private Sector in the Resolution of Financial Crises – The Treatment of Claims of Private Sector and Paris Club Creditors – Preliminary Considerations”, (EBS/01/100), June 27, 2001. See also “Note by Staff on Official Bilateral Creditor Claims and SDRM” (SM/03/51), February 5, 2003.
Not all official bilateral creditors are members of the Paris Club. Achieving a coordinated restructuring that includes all official debt requires separate coordination efforts with non-Paris Club debtors. Experience indicates that non-Paris official bilateral creditors often restructure on terms very similar to those agreed in the Paris Club.
This implies that the coverage of the rescheduling may not necessarily be consistent with broader sustainability considerations.
A somewhat different form of insurance – against the risk of the overall restructuring deal not achieving a (permanent) exit from the unsustainable debt situation – is included in the bonds that emerged from Ecuador’s debt exchange. In particular, should Ecuador default again the bonds stipulate that the principal outstanding prior to the 2000 exchange would be reinstated.
Official bilateral creditors have argued that their policy of holding their claims to maturity and generally eschewing trading claims in secondary markets benefits private creditors by preserving the secondary market value of private investors’ claims. Moreover, the fact that Paris Club creditors reschedule over extended periods at interest rates linked to their cost of funds typically implies a substantial reduction in the present value of claims when discounted at the secondary market yield on the debtor’s other liabilities. In addition, in some cases, debtors have obtained rescheduling of their claims to the Paris club creditors after extended periods of arrears while remaining current on their obligations with the private sector.
Annex to the Deauville Communiqué – A New Paris Club Approach to Debt Restructuring.
See “Involving the Private Sector in Forestalling and Resolving Financial Crises – The Role of Creditors’ Committees – Preliminary Considerations”, (SM/99/206), August 11, 1999, for an overview of historical experience with standing creditor bodies. See also “The Corporation of Foreign Bondholders”, by Paulo Mauro and Yishay Yafeh (WP/03/107).
Among the proposals by the private sector, is a proposal for a forum, including a mediation services element, by Richard A. Gitlin, “A Proposal, Sovereign Debt Forum”, oral presentation at IMF Legal Department and IMF Institute Seminar on Current Developments in Monetary and Financial Law, May 9, 2002.
For a detailed discussion of collective action clauses, see, The Design and Effectiveness of Collective Action Clauses, SM/02/173 (06/07/02). For a detailed discussion of exit consents, see: Involving the Private Sector in the Resolution of Financial Crises – Restructuring International Sovereign Bonds, EBS/01/03 (01/11/01) and Seminar on Involving the Private Sector in the Resolution of Financial Crises, The Restructuring of International Sovereign Bonds, Further Considerations, EBS/02/15 (01/31/02.)
Factors that will have a bearing on the first point include the economic circumstances of the debtor, the extent to which nonparticipating claims may be small, rated as “selective default” by credit rating agencies (not withstanding the fact that they continue to be paid during the restructuring period), and the likely liquidity of the instrument. Factors that will have a bearing on the second point include the appetite for litigation (including willingness to bear the financial costs and possible reputational damage), and the availability of assets or payment streams vulnerable to attachment.
In Moldova’s case, the process was greatly facilitated by the fact that the majority of outstanding bonds were held by one asset management company.
The scope of the Uruguay exit consents was narrower than that in Ecuador. The Uruguay exit consents limited the waiver of sovereign immunity, which sought to exclude future payments on the new bonds from the assets available for attachment in a suit brought on the original bonds. In the Ecuador case, the use of exit consents was perceived as part of “take-it-or-leave-it” strategy. In Uruguay, participants could opt out of the exit consents.