Sovereign Debt Restructuring Mechanism Research Articles

Normative Framework for the Regulation of Holdout Creditors in the Sovereign Debt Market

Abstract This article challenges the contemporary negative and dismissive narratives about distressed debt hedge funds (DDHFs), a subset of holdout creditors. A soft normative framework for regulating this category of creditors and other holdout creditors is however proposed to address their disruptive activities in the sovereign debt market. It is proposed that the Basel III framework be a conduit for enforcing the proposed normative framework because hedge funds are customers of institutions subject to Basel III oversight. One of the characteristics of these funds is their relatively sophisticated and high use of leverage. The authors therefore envisage the Basel III framework being expanded to provide for enforcement in this context. Finally, the normative framework proposed in this article differs from previous proposals including the Sovereign Debt Restructuring Mechanism (SDRM) and contractual solutions including Collective Action Clauses (CACs) and exit consents as it proposes the Basel III framework as an enforcement mechanism and is not a contractual solution.

The political economy of euro area sovereign debt restructuring

The establishment of a sovereign debt restructuring mechanism (SDRM) is one of the important issues in the academic debate on a viable constitution for the European Monetary Union (EMU). Yet the topic seems to be taboo in official reform contributions to the debate. Against this backdrop, the article identifies the SDRM interests of key players, including the European Commission, the European Parliament, the European Central Bank and national governments. The empirical section takes advantage of the recently established EMU Positions Database. The findings confirm political economy expectations: Low-debt countries support an EMU constitution that includes an insolvency procedure whereas a coalition of high-debt countries and European institutions oppose it. The analysis points towards a possible political-economic equilibrium for coping with sovereign insolvencies: an institutional set-up without an SDRM and with hidden transfers. Recent European fiscal innovations in response to the Covid-19 solvency shock confirm this prediction.

The Political Economy of Euro Area Sovereign Debt Restructuring

The establishment of a sovereign debt restructuring mechanism (SDRM) is one of the important issues in the academic debate on a viable constitution for the European Monetary Union (EMU). Yet the topic seems to be taboo in official reform contributions to the debate. Against this backdrop, the article identifies the SDRM interests of key players, including the European Commission, the European Parliament, the European Central Bank and national governments. The empirical section takes advantage of the recently established EMU Positions Database. The findings confirm political economy expectations: Low-debt countries support an EMU constitution that includes an insolvency procedure whereas a coalition of high-debt countries and European institutions oppose it. The analysis points towards a possible political-economic equilibrium for coping with sovereign insolvencies: an institutional set-up without a SDRM and with hidden transfers. Recent European fiscal innovations in response to the Covid-19 solvency shock confirm this prediction.

Designing a Sovereign Debt Restructuring Mechanism for a European Monetary Fund

The establishment of a European Monetary Fund (EMF) enjoys increasing academic and political support, though its advocates do not necessarily agree on the purpose and functions of such an institution. This paper aims to examine the features of the EMF that are relevant to sovereign debt restructuring. We argue that a European sovereign debt restructuring mechanism would be a feasible and useful tool in a crisis. It would facilitate private sector involvement and convey all the advantages that pre-defined procedures offer compared to ad hoc solutions in dealing with a crisis.

Vulture litigation in the context of sovereign debt: global or local solutions?

The idea of “anti-vulture legislation”, i.e. domestic law dealing with holdout strategies and “vulture” litigation against a sovereign debtor in financial distress, differs radically from existing and proposed approaches to deal with sovereign debt crises, such as the contractual approach and the proposal for an international sovereign debt restructuring mechanism. Anti-vulture laws adopted in Belgium, in the United Kingdom and, more recently, in France offer an ambitious local solution to a global problem. Motivated by these developments, we investigate the actual or hypothetical advantages attached to anti-vulture legislation compared to other approaches, and we argue that legislative interventions in sovereign debt-enforcement regimes should be made cautiously with the aim of promoting timely, orderly and equitable solutions to sovereign debt crises.

Public Interests in Sovereign Debt Litigation: An Empirical Analysis

Our research investigates the treatment of public interests in sovereign debt litigation by domestic courts. For our initial dataset, we have collected and coded about 200 decisions of US courts since 1970 (including only selected landmark cases against Argentina). Debtor states usually introduce their public interests into the lawsuit by invoking specific types of legal defenses. We therefore code all legal defenses invoked by the respondent debtor states in the sample and track their success as well as the reasoning of the court with respect to these defenses (e.g., dismissing them summarily or after careful discussion) and the degree of judicial discretion claimed. We find that the use of these defenses and their success has varied considerably over time. Public interest defenses had considerably high success rates in the 1980s and in the 1990s. Only the 2000s saw a decline in their success rate. At the same time, the success rate of private law-based, mostly contractual defenses rose. In the current decade since 2010, the success rate of public interest defenses has plummeted while the effectiveness of private law-based defenses has stagnated. We also discover that the success of both public interest and private law-based defenses is strongly correlated with discretionary reasoning. The upshot of this is that US courts are generally receptive to the political context of their decisions. They have endorsed and supported the spread of holdout litigation during the last decades as an integral part of the deliberate privatization and atomization of sovereign debt markets during the last decades. Even recently, the US government has barely shown its disapproval of such practices and declined to support numerous global initiatives to improve the situation of debtor states. This stands in contrast to the experience of the 1990s, when US courts were still much more receptive to public interest defenses, in line with the political views of the US government and international institutions at the time. It also stands in contrast to the reaction of European courts to challenges of safeguard measures on the level of the European Union and in international arbitration, which is mapped here only anecdotally. On the whole, it seems unlikely that courts are able to preserve the public interest without the support of the political system. This is bad news, as there is currently too little political momentum for a binding international sovereign debt restructuring mechanism, or even a weaker, soft law version of it. Methodologically, this paper tries to bridge the gap between the hermeneutic approach of classical legal scholarship, and empirical legal studies. We make the hermeneutics of court decisions the object of our empirical study. In the future, we plan to expand our research to other jurisdictions to take account of the practice of courts in countries and regions where the hyper-privatization of the market for sovereign debt is viewed more skeptically.

A sovereign debt restructuring mechanism for the euro area? No bail-out and the monetary financing prohibition

A sovereign debt restructuring mechanism for the euro area? No bail-out and the monetary financing prohibition

The new face of developing country debt

Developing country debt has been a major preoccupation for development policy makers and practitioners since the debt crisis of 1982. It is a major obstacle to economic and social progress in developing countries. After the resolution of the Asian financial crisis of the late 1990s and the debt relief initiatives for low-income countries of 1997–2006 concerns about developing country debt seem to have receded. However, there are a growing number of problems that warrant concern, including the accumulation of domestic debt, short-term debt and private non-guaranteed debt, and increasing recourse by low-income countries to international capital markets. At the same time developing countries have strengthened their capacity to oversee and analyse their debt portfolios. Nonetheless, significant weaknesses remain in debt management capacity at the national level. Moreover, the activities of ‘vulture funds’ and the lack of a sovereign debt restructuring mechanism reveal major shortcomings in the international institutional architecture that need to be addressed urgently.

Austerity, Debt Overhang, and the Design of International Standards on Sovereign, Corporate, and Consumer Debt Restructuring

Following the Asian Financial Crisis, sovereign debt defaults prompted calls by the International Monetary Fund (IMF) for a statutory Sovereign Debt Restructuring Mechanism (SDRM). In promoting the SDRM, IMF leaders argued that countries’ sovereign debt problems needed something like U.S. Chapter 11, which is to say that IMF leaders supported the SDRM proposal with reference to legal claims rather than relying on purely economic arguments about the welfare benefits of resolving debt overhang. Framing the debate in this way caught on, but by 2005 the IMF board of directors had rejected the SDRM proposal. The current Global Financial Crisis similarly has resulted in more than several sovereign borrowers’ defaults and has, in turn, renewed calls for revision of the process for restructuring sovereign indebtedness. This time, however, the rhetoric has shifted away from legal metaphor. Rather than comparing sovereign borrowers to corporations in financial distress, sovereign debt has been discussed in terms reminiscent of household debt. Countries should, we are told, practice financial austerity. This paper unpacks the differences among indebtedness owed by public and private, corporate and consumer, borrowers, and the distinct implications for restructuring these different sorts of debt. It argues that modern economic literature on sovereign debt has been chasing the wrong metaphor. The puzzle of sovereign debt shifts when sovereign borrowing is viewed through the lens of consumer (not corporate) borrowing. This shift in metaphor promises more than a new rhetoric.

Redesigning the international lender of last resort

ABSTRACT This paper is concerned with the issue of how to balance bailouts (or into arrears) with debt reductions (or sector involvement) in the resolution of sovereign debt crises. It provides a review of recent proposals for improving the sovereign debt restructuring process. In addition to defending a sovereign bankruptcy proposal we have put forward in recent work, this article proposes a major reorientation of the IMF's role in sovereign debt crises. I. INTRODUCTION Since the Mexican Debt Crisis of 1994-95, which gave rise to an International Monetary Fund (IMF) bailout of unprecedented size, there has been a raging debate on how the IMF should handle sovereign debt crises. Despite the successful resolution of the crisis and Mexico's quick repayment of all its emergency debt, the sheer size of the intervention has raised worries that bailouts could cause significant sovereign debt market distortions. These concerns, in turn, have led to a reconsideration of the prevailing wisdom that the IMF can and should act as the de facto international lender of last resort (ILOLR) by arranging bailouts in response to major sovereign debt crises. As is now widely recognized, the problem with a purely bailout-based policy is that it requires ever larger funds to be credible and successful. It also invites undesirable policies by debtor countries. The prospect of a bailout encourages sovereign debtors to borrow more than they should, and it tempts them to resort to highly risky fixed exchange rate policies as a quick fix towards macroeconomic discipline.1 Of course, the worst debtor misconduct can be controlled to some extent by imposing conditions on the debtor country before granting a rescue program, but more often than not, the IMF finds itself in a weak bargaining position at the onset of a debt crisis. How credible is the IMF threat to withhold a financial aid package when a potentially contagious debt crisis is about to erupt? And once the bailout has been granted, why should the debtor country abide by the conditions it agreed to? Because of the potentially enormous financial commitment a pure ILOLR policy requires, and because of the moral hazard it may induce in sovereign debt markets, it is now widely understood that bailouts need to be supplemented by at least a partial bailin of the private sector. According to this view, the IMF's involvement in a debt crisis should be conditioned on debt reduction or rescheduling by private sector lenders. Private creditors should be required, that is, to share at least some of the costs of resolving a crisis. Despite this emerging consensus on the importance of private sector involvement, however, there is still considerable disagreement on the appropriate balancing between bailout and bailin, and on the best process for crisis resolution and debt restructuring. The most ambitious overhaul of IMF policy contemplated so far involves the introduction of some form of bankruptcy institution for sovereigns and envisions a single forum where the extent of debt reduction and the size of new emergency lending would be decided simultaneously. There was considerable discussion and research of this strategy-which the IMF calls a Sovereign Debt Restructuring Mechanism (SDRM)-from late 2001, when the IMF first announced its support for a sovereign bankruptcy framework, up to the G-10 meetings in April 2003, when the IMF's proposal was shelved. Despite all the writing and debates, many open questions were still unresolved at the time of the G-10 meetings, including the role of the IMF in an SDRJVI regime. No doubt these questions would have received further attention if the SDRM proposal had gone forward. But in the aftermath of the SDRM debate, no clear new role has been marked out for the IMF and no clear rules have emerged to direct the IMF's balancing of bailins and bailouts in future debt crises. As a result, the IMF now finds itself at a crossroads. …

Sovereign debt: the assessment

This article serves as an introduction to two issues of the Oxford Review of Economic Policy, one entitled ‘Sovereign Debt: Understanding Bond Markets During the Eurozone Crisis’ and the second ‘Sovereign Debt: Lessons from the Past, Reforms for the Future’. We begin by documenting recent trends in advanced country sovereign indebtedness and reviewing events that preceded the sovereign debt crisis in the eurozone. The mechanisms through which rising sovereign debt may impact bond yields, economic growth, and inflation are discussed and the evidence for such effects is reviewed. Our discussion highlights that there is no unique threshold beyond which sovereign debt exerts adverse macroeconomic effects, and that in order to understand the consequences of a given debt load one must analyse its structure in terms of internal and external creditors, currency denomination, the time to maturity of the bonds, and the legal code governing debt issuance, as well as various economic and political constraints measuring the fiscal space of the sovereign. We then turn our attention to episodes in which sovereign debt proves excessive and default occurs. We review explanations for the protracted and inefficient nature of defaults and describe some lessons from historical studies examining default outcomes. In the final part of the paper we discuss proposals for averting future debt crises, including jointly issued bonds such as eurobonds, contingent convertible bonds, and elements of a Sovereign Debt Restructuring Mechanism. In the course of our discussion we draw on each of the 11 articles included in the two issues of this journal devoted to sovereign debt.

The Problem of Holdout Creditors in Eurozone Sovereign Debt Restructurings

The Eurozone official sector has declared that the belated restructuring of Greek bonds held by private sector creditors in 2012 was a “unique and exceptional” event, never, ever to be repeated in any other Eurozone country. Maybe so. But if this assurance proves in time to be as fragile as the official sector’s prior pronouncements on the subject of “private sector involvement” in Eurozone sovereign debt problems, any future Eurozone debt restructuring will be surely plagued by the problem of non-participating creditors -- holdouts. Indeed, it is the undisguised fear of holdouts and the prospect of a messy, Argentine-style debt restructuring in the belly of Europe that has been one of the principal motivations for the official sector’s willingness to use its taxpayer money to repay, in full and on time, all of the private sector creditors of Eurozone countries receiving bailouts (the belated Greek restructuring being the sole exception).This article argues that a simple amendment of the Treaty Establishing the European Stability Mechanism (the Eurozone’s new bailout facility) could immunize within the confines of the Eurozone the assets of a Eurozone country receiving ESM bailout assistance from attachment by litigious holdout creditors. By thus increasing the difficulties that holdouts would face in enforcing court judgments against a debtor country, the objective of the amendment is to deflate creditor expectations that staying out of an ESM-supported sovereign debt restructuring will lead to a preferential recovery for the holdouts.This measure would also, when taken together with the other steps that the Eurozone has already implemented, substantially replicate the important features of the Sovereign Debt Restructuring Mechanism proposed by the IMF in 2002.

Playing Sovereign Debt Creditors’ Orchestra: Inter-Creditor Issues in Sovereign Debt Restructuring

Lack of support for the Sovereign Debt Restructuring Mechanism (SDRM) discussion at the IMF a decade ago has encouraged several debt NGOs to actively advance proposals for sovereign debt arbitration - a bankruptcy-type arbitral tribunal to handle sovereign debt disputes in a collective manner. In response to these proposals, the Government of the Netherlands and the Permanent Court of Arbitration recently initiated a project to investigate the desirability and feasibility of sovereign debt arbitration. The interim project report flags, among other issues, the absence of agreed principles that would be applied by the arbitral tribunal. This paper wishes to contribute to the discussion surrounding such principles by addressing inter-creditor issues in sovereign debt restructuring. It begins with an explanation of inter-creditor issues at the time of crisis, and the urgent need for better creditor coordination looking at the Argentine bondholders’ recent success in the Abaclat and NML Capital cases. It draws from the experience of domestic bankruptcy law to explore the best solution for resolving inter-creditor issues in the sovereign debt context. Importantly, this paper challenges the fundamental theory of collectivity in bankruptcy law, arguing that the approach used in most domestic bankruptcy systems to address inter-creditor issues — the inclusion of all claims in a collective proceeding that ensures equitable treatment among all creditors - should be applied differently in the sovereign debt world due to the difference of the debtor being a State.

Sovereign Insolvency in the Euro Zone Public and Private Law Remedies

In the wake of the global financial crisis, the economically weaker countries of the European Union that adopted the euro as a common currency soon started to feel the pressure of markets. In a monetary union, with one single central bank in charge of the monetary policy but without a common fiscal policy, or even an adequately coordinated one, those countries with oversized government structure and/or an internal balance of payments deficit became rapidly affected by the lack of confidence that was rapidly spreading in the global financial markets. It started with Greece, moved to Ireland and Portugal and the risk of full contagion to Italy and Spain, the euro zone's 4th and 5th largest economies, posed a real threat to the existence of the euro itself. In light of this, the EU has realized the need to react. Some new measures have been adopted and more – the majority – have been announced but are not even underway yet. This article concentrates on the measures that relate directly to the risk of insolvency of a member state; to its prevention, control and avoidance (ex ante mechanisms), and to the instruments foreseen for its solution (ex post mechanisms, with particular regard to the new European system of collective action clauses). It is here suggested that the measures aimed at strengthening the controls, increasing transparency and beefing up the powers of the European institutions create a robust framework capable of avoiding future crises. Conversely, it is argued that the reactive mechanisms envisaged in the new framework might not be so adequate. Europe might have erred by prioritizing “public law” solutions over “private law” mechanisms, since this type of approach could lead to unfair and inefficient results. Although the European collective action clauses will not help to solve the current crisis, they could place euro zone countries in a better position to tackle future sovereign crises. However, the current design of collective action clauses could be improved and uncertainties remain as to their implementation. It is here concluded that there has not been a better time than this one to opt for a comprehensive solution to sovereign insolvency in the euro zone, a solution that involves public and private creditors in an organized, full sovereign debt restructuring mechanism.

American States and Sovereign Debt Restructuring: Lessons and Cautionary Tales

As American states continue to struggle with low revenues and growing financial obligations, a number of commentators have proposed that states should be able to seek relief under bankruptcy law. Currently, there is no formal mechanism for facilitating the efficient restructuring of states’ obligations if that becomes necessary or desirable. American states and sovereign nations are similar in this respect. As this Article (forthcoming in Conti-Brown and Skeel, eds., Confronting Fiscal Crisis in American State Government) explains, however, the history of sovereign debt crises and debt restructuring reveals that much can be done in the absence of a formal mechanism. The primary lesson from the experience of sovereign debtors is that a state experiencing acute financial crisis will likely find a way to encourage its counterparties to agree to restructure or reduce their claims, even if they have no legal obligation to do so and have some legal basis for objecting. Thus, a formal mechanism is probably not necessary for a successful restructuring of a state’s obligations if one is truly necessary. It may be suboptimal to force a state to reach the point of acute crisis before it can gain its creditors full attention, and the overall costs of ad hoc restructuring may be higher for states and their creditors (and the federal government) than those of reorganization in bankruptcy. But the history of efforts to promote a sovereign bankruptcy regime or a sovereign debt restructuring mechanism indicates that even if there is room for improvement over an ad hoc approach, there is unlikely to be much of an appetite among policymakers for adopting a more formal mechanism.

Chapter 9 Versus Chapter 11 after Orange County – Lessons for the SDRM

This paper was written in 2003 for the International Bar Association conferences in Rome, Italy. As Co-Chair of a panel on Sovereign Debt Restructuring, I wrote this to highlight a general shortfall in analysis of the International Monetary Fund’s Sovereign Debt Restructuring Mechanism. The SDRM was drafted based on the U.S.’s Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). This paper points out that Chapter 9 of the Bankruptcy Code, dealing with political subdivisions of States was a better model for any transnational insolvency regime.

Sovereign Insolvency and International Legal Order

AbstractThe rescue of States in a financial crises has been classically managed by way of official lending, mainly managed by the IMF, where international law played the major role. In most recent cases, to the contrary, this has mainly become a private law issue: since debtors, including sovereign, undertake exposure on a contractual basis, repayment or negotiation of the debt is governed by such same contract. These present a number of pitfalls and shortcomings which have been tried to be solved by a number of solutions. Each of them, however, not only is not fully satisfactory, but cannot take into account all interests at stake. To this end, a number of projects have been elaborated, to regulate the matter at the international level, starting from the Sovereign Debt Restructuring Mechanism of the IMF to other proposals of international bankruptcy codes, none of which has been adopted. The present contribution analyses the consequences of these proposals on sovereignty and how alternative approaches could better respond to international stances while respecting private tools.

Recent Episodes of Sovereign Debt Restructurings: A Case-Study Approach

Sovereign debt restructurings do constitute a recurrent phenomenon in emerging and developing economies. Consequently, the international community has repeatedly explored options to increase the predictability and orderliness of debt workouts, of which the debate on the Sovereign Debt Restructuring Mechanism (SDRM) proposed by the IMF in 2002 is the most recent example. Eventually, however, the most ambitious reform proposals have been systematically abandoned, thereby consolidating debt restructurings as market-led case-by-case processes. This paper reviews nine recent sovereign debt restructurings: Argentina (2001-2005), Belize (2006-2007), the Dominican Republic (2004-2005), Ecuador (1999-2000), Pakistan (1998-2001), the Russian Federation (1998-2001), Serbia (2000-2004), Ukraine (1998-2000) and Uruguay (2004). Our case study analysis reveals the lack of a single model for sovereign debt restructurings. Indeed, we find significant variations in the roots of the crises, the size of the losses undergone by investors, the speed at which an agreement was reached with creditors, the proportion of creditors accepting the terms of that agreement, or the time needed to restore access to international financial markets. There also appears to be a lack of consistency in the role played by the IMF in the various crises. This is partly due to the lack of a policy specifically designed to deal with sovereign debt restructurings in the IMF's toolkit, which has provided the IMF with flexibility to adapt to each crisis on a case-by-case basis. However, it may have exacerbated the uncertainty that tends to characterize such disruptive episodes. This paper constitutes the basis of a broader effort to identify possible options for the IMF to endow itself with a policy to streamline and systematize its role during sovereign debt restructurings.

The Mystery of the Missing Sovereign Debt Restructuring Mechanism

The absence of a formal international regulatory mechanism to facilitate sovereign debt restructuring has long been recognized as a most serious gap in the architecture of global finance. Why has it proven so difficult to create such a sovereign debt restructuring mechanism (SDRM) at the international level? Political economists have devoted relatively little scholarly attention to this question. This paper attempts to begin to fill this gap in the literature by examining four failed initiatives to create a SDRM over the past century. In place of a realist or structural Marxist account, the paper puts forward a more contingent explanation for these failures that highlights three distinct political problems that must be overcome in the construction of a SDRM: (1) collective action problems on both the side of sovereign debtors and that of private foreign creditors; (2) basic distributional conflicts embodied in any debt restructuring effort; and (3) the uncertain behavior of the private creditors' home states.

Reviving Troubled Economies

There would be few dissenters from the general proposition that we should try to deal justly with debt. We have all watched in horror the collapse that has taken place in Argentina and the enormous cost paid by so many people in that country—as well as by the creditors of Argentina—from the massive financial and economic dislocation and disruption. I do not believe that what has occurred was inevitable.Unfortunately, some who address this issue of dealing with unmanageable debt situations have offered advice that, while emotionally appealing, is not operationally helpful. I will describe and justify the rationale and design of the proposal put forward by the International Monetary Fund for a Sovereign Debt Restructuring Mechanism (SDRM). Its major goal is to help reduce the unacceptably large costs associated with disorderly defaults by sovereign governments whose debt burdens have become unsustainable. The SDRM aims to get the countries' debts to sustainable positions and deal with the broader needs of the countries through the full array of aid and other mechanisms that are available— and, indeed, to enlarge and enhance these initiatives. I will also explain my misgivings about some of the other proposals, including the ones coming from the NGO community.