Sovereign Bond Restructuring: Collective Action Clauses and Official Crisis Intervention

Abstract

This paper discusses the collective action problem in sovereign debt restructurings using a benchmark model of sovereign debt renegotiation. It considers the welfare comparison of outcomes sustainable under collective action clauses and under governing law that requires the unanimous agreement of bondholders to repayment revisions. One conclusion is that collective action clauses allow the implementation of an efficient renegotiation equilibrium for the model economy while unanimity rules provide incentives for opportunistic behavior by individual bondholders that leads to inefficient outcomes. The potential role for a multilateral sovereign debt restructuring mechanism (SDRM) is also discussed. It is argued that the establishment of an official international bankruptcy tribunal that collectively restructures all of a country’s debt may not improve upon the universal adoption of collective action clauses for sovereign bond issues. With collective action clauses, mutual gains from collective renegotiation are internalized so that sufficient incentives exist for the private formation of bondholder councils to restructure various debt issuestogether. The approach abstracts from transactions costs, and the last conclusion might well be sensitive to renegotiation and coordination costs. This paper was presented at the Bank of England conference, “The Role of the Official and Private Sectors in Resolving International Financial Crises” July 23 and 24, 2002 in London. I thank Prasanna Gai, Andrew Haldane, Simon Hayes and Adrian Penalver for their invitation and comments on the paper. I also thank my discussants, Willem Buiter and Matthew Fisher, for their extensive, thoughtful and useful comments.