THE PROBLEM OF SOVEREIGN DEBT RESTRUCTURING: HOLDOUT PROBLEM AND EXIT CONSENTS

Abstract

This paper examines the validity and effectiveness of the use of exit consents, a restructuring technique often applied when restructuring corporate bonds, in dealing with the holdout problem in sovereign debt restructuring. In recent restructuring, exchange offers have proven nearly indispensable. However, this technique leads to an intractable problem known commonly in law and finance as holdout. Through holdout, some bondholders who do not accept the new bonds in replacement of original bonds may seek full payment through threat of litigation. By so doing they may seriously disrupt and even stall a restructuring process. Exit consents are thought to form a vital tool in providing negative incentives in respect of existing bonds by reducing the market value of these bonds, and this method has in fact been applied in recent sovereign bond restructuring. However, the legality and effectiveness of this technique has yet to be carefully examined. This paper mainly argues that since sovereigns cannot be liquidated, the resultant lack of liquidation values significantly reduces the applicability and effectiveness of this technique relative to cases of corporate bond restructuring. The paper then provides concrete requirements to be considered in the evaluation of the validity of this technique, and also describes how the lack of liquidation risk affects these requirements. Using a practical example of incentives schemes, this study concludes that in the absence of the discipline provided by bankruptcy procedures for sovereigns, schemes that provide positive incentives to creditors to accept exchange offers are critical in restructuring sovereign bonds.