Sovereign Debt Restructuring: Lessons from History

Abstract

The current “rules of the game” of the European Monetary Union, namely a fixed exchange rate, open capital accounts and the prohibition of monetary financing of government debt, have re-introduced sovereign default risk to its member states. Against this backdrop, this paper discusses options for more orderly sovereign debt restructurings in Europe, including Collective Action Clauses. A review of recent sovereign debt restructurings shows that debt restructurings have typically taken the form of sovereign bond exchanges since lending relationships became dominated by market intermediation instead of bank intermediation. These debt swaps have largely avoided the problems of holdouts, but they have also been characterised by sometimes-excessive haircuts, discrimination against traditional investors, and undue delay, which is in part due to the lack of creditor representation. In order to overcome the identified shortcomings of debt exchanges, sovereign borrowers, multilateral institutions and the ECB should respect the principle of preference avoidance in future debt restructurings. Furthermore, EU member states that entertain a sovereign debt restructuring should be required to facilitate creditor representation by covering reasonable legal and actuarial expenses of creditor committees. Contractual novations such as the introduction of Collective Action Clauses can help to overcome the ability of small groups of non-consenting creditors to obstruct a debt restructuring process or to gain payment preference, but they are not needed in the euro area, since government bonds have largely been issued under domestic law and can thus be restructured unilaterally, if needed.