Sovereign Debt Management Research Articles

Sovereign Debt Restructuring, Refinancing and the Financial Market

Abstract Lienau’s book on ‘Rethinking Sovereign Debt’ delves into international finance to shed light on its background rules, overarching ideologies and interacting actors, disentangling the social norm of sovereign debt continuity and its institutional foundations. What a formalistic legal reasoning would interpret as a self-contained bilateral contract is then situated in historical time and social space populated by a variety of actors (debtors and creditors), co-existing legal regimes and evolving principles of reference. Her focus on odious debt highlights situations where debt continuity is challenged by major events in the sovereign borrower status (such as major political regime change, corruption and human rights abuse) which challenge debt legitimacy. This comment expands on her thoughtful analysis by linking debt continuity to the borrowing sovereign entity as a going concern. Sovereign borrowing makes lenders involved with this ongoing entity through time and circumstances. Ongoing sovereign debt management is featured by both debt securities market trading and the refinancing mechanism. In turn, refinancing involves public finances with their public benefit missions, central banking and the monetary base management. In this context, socially responsible lending and borrowing may be facilitated by acknowledging the bonding relationship between the borrowing sovereign entity and its creditors, including when default occurs.

The Rise of the Notion of Illegitimate Debt: a Comment on “Rethinking Sovereign Debt: Politics, Reputation, and Legitimacy in Modern Finance” by Odette Lienau

Abstract “Rethinking Sovereign Debt: Politics, Reputation, and Legitimacy in Modern Finance” by Odette Lienau convincingly challenges the notion that the norm of debt continuity is a “stable and inevitable market principle” by providing a thorough analysis of the historical and political contexts surrounding this norm. The author’s approach which goes beyond the “market narrative” on the norm of debt continuity provides significant insights into the difficult issues of debt repudiation. This approach reveals the politically and historically variable nature of the norm of debt continuity. As such, the author demonstrates the openness and the possible development of sovereign debt practices towards accepting a more flexible and non-statist approach to sovereign debt management.

Where states and markets meet: the financialisation of sovereign debt management

ABSTRACTFinancial markets play an indispensable role in the management of sovereign debt, that is, the mechanics of how and from whom governments borrow. This paper suggests a novel, two-dimensional concept to measure the financialisation of sovereign debt management (SDM): (1) the reliance on financial markets as a governance mechanism and (2) the adoption of a sense-making framework grounded in financial economics. We split this concept into nine indicators and apply it to data from 23 OECD countries between 1980 and 2010. Our analysis illustrates the predominant commonalities across countries, but at the same time, country-specific differences. We interpret them as two sides of the same coin in the light of an overarching trend of increasing alignment to financial markets. This article is not only one of the first cross-national as well as longitudinal studies of the dynamics in SDM; it also reveals that the relationship between finance and governments in the SDM is by no means one-sided.

Courts and sovereigns in thepari passugoldmines

The pari passu clause in sovereign bond contracts has spawned an improbably huge academic literature and a fast-growing jurisprudence, culminating in recent U.S. federal court decisions, which used the clause to block payments on nearly $30 billion in Argentinian debt. The academic literature, judicial opinions, briefs and expert reports going back to the mid-1990s all assume that no court had interpreted the pari passu clause in sovereign debt before the year 2000. It turns out that there were at least four instances of such interpretation in the twentieth century.This essay discusses litigation in Switzerland in the 1930s and a decade-long international arbitration in the 1970s, in which four different panels considered the meaning of pari passu clauses in German Young Loan bonds. All four panels interpreted the clause in ways that might well be consistent with those of the U.S. federal courts; however, the bondholders still lost.Documents from the League of Nations archives suggest that the 1930s lawsuit against the Bank for International Settlements as trustee for the German bonds influenced proposals for contract and institutional change in sovereign debt management, notably with respect to the role of the bond trustee. To the extent such reforms might have had a chance, World War II and its aftermath put them on hold until the turn of the 21st century. As the dust from Argentina's debt saga begins to settle, the old disputes over the meaning of pari passu offer unexpected lessons for debt enforcement and contract reform.

Determinants of complexity of sovereign debt negotiation

IntroductionThe recent negotiation with Greece and other cases of external indebtedness of developing and developed countries remind about unsolved challenges of sovereign debt management. Frequently, the decisive part of sovereign debt management is its restructuring, which is achieved in the long lasting and complex, multi-party negotiation.While there exists a vast literature about international debt, the negotiation process itself has usually been given less attention. Most of the studies are focused upon formal aspects of negotiation, e.g. modelling the bargaining process with dynamic, stochastic, general equilibrium model. Such problems as the process of negotiation, bargaining phases, behavior of negotiators, structure of negotiation situation, the consequences of multi-actor negotiation have not yet been studied profoundly.There is another aspect of the situation on all financial markets which is associated with their increasing complexity. It is reflected in variety of applications of that term in the public discourse on finance, including also sovereign debt. Negotiation of sovereign debt is by definition a complex endeavor. Its complexity results both from structural characteristics - number of actors, problems of coordination, communication, cooperation and conflict as well as from cognitive boundaries. Recently, complexity of debt restructuring negotiation has even increased due to overall uncertainty in the world economic system and due to new specific determinants of the debt restructuring cases, e.g. the Greece's debt crisis. The survey of literature on sovereign debt management shows that no research has been done on complexity of the sovereign debt management, and sovereign debt negotiation in particular.The aim of the paper is to provide initial framework concepts of complexity of sovereign debt restructuring negotiation referring to a universal collection of characteristics of negotiation. A model of debt restructuring negotiation is elaborated and the set of complexity-related characteristics of negotiation is proposed.Although the term complexity is frequently used in the discourse on negotiation, including debt restructuring negotiation, usually it is defined in an imprecise manner. Therefore the definitions of complexity are explained in the paper in a more rigorous way. The ideas presented in the paper can be used in a deeper understanding of the sovereign debt negotiating processes, their institutional determinants and behavior of the parts involved. The approaches based solely upon statistical analysis and rational assumptions about decision makers are insufficient, especially under the contemporary circumstances.In the first part of the paper, sovereign debt and negotiation associated with its restructuring are discussed. Definitions of 'hard' and 'soft' complexity are presented in the second part. In the third part, the structure and the process of debt restructuring negotiation are depicted. In the final part the attributes of complexity of debt restructuring negotiation are proposed. Potential applications of complexity-related ideas drawn from theory of negotiations are also scrutinized in the last part.1.Sovereign debt negotiation: A descriptive approach1.1.Sovereign debt and its restructuringSovereign debt (public / government / national debt) is issued by a national government. It is theoretically considered to be risk-free, as the government can employ different measures to guarantee repayment, e.g. to increase taxes or to print money. Government debt can embody internal debt (owed to lenders within the country) and external debt (owed to foreign lenders).In practice, there have been multiple cases in which governments could not serve their debt obligations and had to default. As a consequence, investors ask for different yields across countries. The more a country's repayment ability is in question and the riskier sovereign debt becomes, the higher is its yield. …

Performing neoliberal governmentality: an ethnography of financialized sovereign debt management practices

Performing neoliberal governmentality: an ethnography of financialized sovereign debt management practices

ANALYSIS OF LITHUANIAN CREDIT DEFAULT SWAPS

This paper studies international sovereign Credit Default Swaps (CDS) market focusing attention to the CDS of Central and East Europe. The main purpose of the study was to perform detail analysis of Lithuanian CDS in the global capital market. We compared the CDS markets of other countries and found some commonalities between them. We study the credit curve produced by CDS and volatility of CDS. A great attention is paid to investigate the relationship of CDS and the government bond market. Analysis of finding a leading role of CDS and the bond markets in the price discovering process is made. A leading market for different periods is found by using the Vector Error Correction model. Our main finding is that during the volatile period price discovery takes place in the bond market and in the calm period price discovery is observed in the CDS market. Disclosed relationship between CDS spreads and Eurobonds yield risk premium gives an additional decision making tool for sovereign debt managers.

The Challenge of Sovereign Insolvency - Critique and Commentary on Towards a Reorganisation System for Sovereign Debt, by Holger Schier

A Reorganisation of the system of sovereign insolvency holds the potential of putting some order and ensuring greater efficiency in the management of Sovereign Debt. The practice and procedure of sovereign debt management is largely still unregulated and so unpredictable as debtor default and creditor response depends on the impulses of the parties as the Argentine cases has shown. Dr Holger Schier offers much that puts some clarity in the book on several aspects of the law of sovereign insolvency. The Greek debt crisis has brought the situation home to the Eurozone but the experience of managing the Sub-Saharan debt will prove instructive all the same.

<i>Pari Passu's</i> Golden Fossils

The pari passu clause in sovereign bond contracts has spawned an improbably huge academic literature and a fast-growing jurisprudence, culminating in recent U.S. federal court decisions, which used the clause to block payments on nearly $30 billion in Argentinian debt. The academic literature, judicial opinions, briefs and expert reports going back to the mid-1990s all assume that no court had interpreted the pari passu clause in sovereign debt before the year 2000. It turns out that there were at least four instances of such interpretation in the twentieth century.This essay discusses litigation in Switzerland in the 1930s and a decade-long international arbitration in the 1970s, in which four different panels considered the meaning of pari passu clauses in German Young Loan bonds. All four panels interpreted the clause in ways that might well be consistent with those of the U.S. federal courts; however, the bondholders still lost.Documents from the League of Nations archives suggest that the 1930s lawsuit against the Bank for International Settlements as trustee for the German bonds influenced proposals for contract and institutional change in sovereign debt management, notably with respect to the role of the bond trustee. To the extent such reforms might have had a chance, World War II and its aftermath put them on hold until the turn of the 21st century. As the dust from Argentina's debt saga begins to settle, the old disputes over the meaning of pari passu offer unexpected lessons for debt enforcement and contract reform.

Theory of Optimum Financial Areas: Retooling the Debate on the Governance of Global Finance

This article examines the institutional preconditions for stable financial integration in a ‘theory of optimal financial areas’ (OFA). This theory is modelled on the theory of optimal currency areas that has been used to inform the process of monetary integration. Where it differs from optimum currency area (OCA) theory is in focussing on capital mobility and cross-border financial transactions rather than concentrating on exchange rates or macroeconomic adjustment. We contend that OCA theory misdirects both the analysis and the policy response: it is more pertinent to ask what makes for financial stability under conditions of market integration than what makes for stable currencies and smooth macroeconomic adjustment. The article proposes six ‘criteria’ that should be met in order to stabilize an integrated financial ‘market geography’. Three of these criteria relate to the technical substructure of markets, and include a shared risk free asset, centralized sovereign debt management, and common market infrastructures for communication, clearing, settlement and depository. Three further criteria focus on the macro-prudential considerations like shared rules for financial supervision, centralized lender of last resort facilities for private- and public-sector market participants, and common provision for the resolution of failed private- and public-sector borrowers. These criteria are controversial both individually and as an interdependent package. Nevertheless, they are important to mitigate the costly dynamics of financial market disintegration under crisis conditions. We use case studies of the Great Britain, the United States and Canada to show how national governments have stumbled toward a similar set of arrangements to stabilize domestic financial market integration. The more recent experience of the European Union shows this pattern applies across countries as well. We conclude with a research agenda based on these considerations.

Risk profiles for re-profiling the sovereign debt of crisis countries

Purpose– This paper aims to use a risk management approach for re-profiling of sovereign debt. It develops profiles that trade off expected cost of financing alternative debt structures against their risk. The risk profiles are particularly informative for countries facing sovereign debt crisis, as they allow us to identify, with high probability, debt unsustainability. Risk profiles for two eurozone countries with excessive debt, Cyprus and Italy, were developed. In addition, risk profiles were developed for a proposal to impose debt sanctions in the Ukrainian crisis and it was shown that the financial impact could be substantial.Design/methodology/approach– Using scenario analysis, a risk measure of the sovereign’s debt – Conditional Debt-at-Risk – was developed, and an optimization model was then used to trade off expected cost of debt financing against the Conditional Debt-at-Risk. The model is applied to three diverse settings from current crises.Findings– The methodology traces informative risk profiles to identify sustainable debt structures. Interesting, although tentative, conclusions are drawn for the countries where the methodology was applied. Cyprus’s debt sustainability hinges on current International Monetary Fund (IMF) projections about gross domestic product growth and small deviations can push debt into unsustainable territory. For Italy, our analysis provides evidence of debt unsustainability. Common assumption of debt by eurozone member states could restore sustainability for Italy. Finally, it is shown how a proposal to impose debt sanctions against Russia for the Ukrainian crisis could have significant financial impact for Ukraine.Research limitations/implications– Additional work is needed to calibrate the simulation models for each country separately. Nevertheless, the direction of the results is such that more careful calibration will most likely not alter the conclusions but make them stronger instead.Practical implications– The results provide significant insights for the management of sovereign debt for Cyprus and Italy. They also show the significant positive impact on Ukrainian public finances from debt sanctions. However, the most important practical implication is to show how the proposed methodology provided a decision support tool for restructuring and rescheduling sovereign debt for crisis countries.Social implications– There is widespread acceptance that debt restructuring has been too little and too late in recent crises failing to re-establish market access in a durable way. How to develop risk profiles for alternative debt structures has been illustrated. Debt profiles that are unsustainable can be identified, with high probability, and alternative structures proposed that restore sustainability. The methodology proposed in this paper is providing a useful tool of analysis. The topic of debt relief is currently debated widely at policy circles by the IMF and the United Nations, and the analysis of this paper provides some insightful input to the debate.Originality/value– The use of scenario analysis for sovereign debt modeling and the use of an optimization model developed by the authors in previous research provide empirical analysis for three current problems in sovereign debt management. Useful insights are obtained for three important real-world cases for Cyprus, Italy and Ukraine.

Enhanced Debt Management: Solving the eurozone crisis by linking debt management with fiscal and monetary policy

Unconventional approaches to suit unusual circumstances have become acceptable in monetary policy, a formerly highly conservative discipline. In this paper it is argued that unconventional approaches should also be considered in sovereign debt management, in order to contribute to resolving the eurozone sovereign debt crisis. First, the Troika crisis lending to indebted sovereign borrowers in the eurozone is reviewed and compared with standard IMF post-crisis lending. The main difference and shortcoming is the unsustainable character of the eurozone approach, due to the omission of demand stimulation components. To address this and other shortcomings, the features of an ideal alternative funding tool are identified. It would solve the funding problems of affected sovereigns, help stabilise the banking system, but most of all stimulate domestic demand and hence end the vicious downward spiral. It is found that this funding method can be implemented as part of enhanced public debt management by each nation's debt management office.

Public sector reforms and sovereign debt management: Capital market development as strategy?

The reform of sovereign debt management has largely escaped attention in the accounting literature on public sector financial management reforms. The application of business thinking to the public sector has meant conceptualising the sovereign debt management function as a corporate-style controller function, applying to sovereign debt management the asset and liability management techniques developed in the banking sector. Accruals-based appropriations and outcomes-focused strategy statements weaken a legislature's power of control over the executive government and divert attention from the control of public finance, which increasingly appears to be delegated to the executive government. Wider application of the asset and liability management techniques adopted for sovereign debt management seems to support an emergent capital market development strategy, facilitated by increasing government participation in capital markets. The New Zealand government's financial statements help to illustrate these developments and show the extent of government participation in capital market activities involving large amounts of public money and leveraging of public assets. Financial control and accountability is not achieved by relying on strategy statements, objectives and ex post review.

The UK and the Eurozone: Sovereign Debt Management and Monetary Policy

AbstractEvents in the wake of the ‘credit crunch’ can be understood only against institutional structures within which interdependent monetary and fiscal policy are administered. In the Eurozone, the attempt to keep a central monetary authority (together with its associated national central banks) independent from 17 diverse fiscal authorities was flawed. When sovereign debt approaches unmanageable levels, the Maastricht Treaty presents austerity as the single option. In the UK, the electorate has an opportunity to choose between monetary financing (inflation) and fiscal consolidation (austerity). Policy choices within the Eurozone and the UK are set against Keynes's focus on unemployment and more recent concerns to retain (or restore) price and/or financial stability.

Can NATO survive an accident prone Euro?

The European Monetary Union (EMU) is inherently unstable, and will be prone to repeated financial and fiscal crises. These crises pose a clear threat to NATO security and the political institutions of Alliance member states. There is no definitive way to eliminate the risks posed by monetary union, but straightforward reforms in EMU sovereign debt management represent a low-cost near-term means of mitigating these risks. With EMU nations facing a seeming leadership vacuum, it is well within NATO purview to press for adoption of such reforms.

CHOOSING THE CURRENCY STRUCTURE OF FOREIGN‐CURRENCY DEBT: A REVIEW OF POLICY APPROACHES

AbstractStarting from the constraints and incentives that cause countries to issue debt in foreign currency, this paper provides an overview of policy approaches for choosing the optimal currency structure of sovereign foreign‐currency debt. The objective of sovereign debt managers generally includes both risk and cost minimisation, while constraints to foreign‐currency debt allocation originate in the parameters of the domestic macroeconomy, the shocks it faces and the initial conditions. Overall, the main parameters that drive the solutions for optimal currency allocation of foreign‐currency debt are the covariances of macrovariables with exchange rates and the variances of different exchange rates. Both the covariances and the exchange rate volatility can be deceptive when a fixed exchange rate regime is maintained, however. To adequately capture the expected covariances in the context of managed exchange rate regimes, we suggest that sovereign debt managers work with equilibrium instead of actual exchange rates. For the same reason and because the estimates of relative exchange rate variances should be forward looking, we suggest using synchronisation indicators in the policy analysis to better capture the underlying drivers of exchange rate volatility across currencies. Copyright © 2010 John Wiley & Sons, Ltd.

Assessing Sovereign Debt Strategies Under Alternative Term Structure Models*

This paper examines the theoretical restrictions on alternative term structure models in assessing sovereign borrowing strategies. Our approach draws upon Hahm & Kim’s (2003) cost–risk analytic model of sovereign debt management within a mean–variance framework. To explore the effects of different interest rate modeling strategies on government debt portfolio selection, two models are considered; namely, the time series-based dynamic Nelson–Siegel (DNS) model proposed by Diebold & Li (2006) and the DNS model with arbitrage-free restrictions proposed by Christensen et al. (2008a). Using monthly spot rates for 12 maturities of nominal Korea Treasury Bonds (KTB) from September 2000 to November 2008, the present paper finds that a more generic term structure model, such as the DNS model, performs better in terms of smaller out-of-sample root mean squared errors at different forecast horizons. However, looking at the goodness-of-fit, the size of pricing errors and the magnitude of the root mean squared errors suggests that both models are reasonable representations of KTB spot curves. For the actual KTB position as of December 2007, the present paper shows that the 95% cost-at-risk level might be able to trim as much as 5–6% by rebalancing the portfolio. Furthermore, DNS models, both with and without no-arbitrage restrictions, produce a consistent assessment of different strategies. This paper also shows that introducing new short-term domestic debt instruments, such as 1-year zero coupon KTB, would benefit government in terms of lowering both the average debt-service cost and the 95% cost-at-risk. However, it is found that such benefits might dissipate if the issuance weights for such instruments exceed a certain level, which is approximately 4% of the position in the case of Korea.

The Surge in Borrowing Needs of OECD Governments: Revised Estimates for 2009 and 2010 Outlook

OECD governments are facing ongoing, unprecedented challenges in raising smoothly large volumes of funds at lowest possible cost, while balancing refinancing-, repricing- and interest rate risks. Amidst continued uncertainty about the pace of recovery as well as the timing and sequencing of the steps of the exit strategy, gross borrowing needs of OECD governments are expected to reach almost USD 16 trillion in 2009, up from an earlier estimate of around USD 12 trillion. The tentative outlook for 2010 shows a stabilising borrowing picture at around the level of USD 16 trillion. A looming additional challenge is the risk that when the recovery gains traction, yields will start to rise. Although there are signs that issuance conditions are becoming tougher, most OECD debt managers have been successful in financing the surge in funding needs. Less successful auctions can therefore best be interpreted as “single market events” and not as unambiguous evidence of systemic market absorption problems. The future could become more challenging though, given that rising issuance is occurring in tandem with increasing overall debt levels and debt service costs. In response, sovereign debt managers, with the essential support of the fiscal authorities, need to implement a timely and credible medium-term exit strategy to avoid future crowding out and systemic issuance problems, while reducing government borrowing costs.

The surge in borrowing needs of OECD governments

OECD governments are facing ongoing, unprecedented challenges in raising smoothly large volumes of funds at lowest possible cost, while balancing refinancing-, repricing- and interest rate risks. Amidst continued uncertainty about the pace of recovery as well as the timing and sequencing of the steps of the exit strategy, gross borrowing needs of OECD governments are expected to reach almost USD 16 trillion in 2009, up from an earlier estimate of around USD 12 trillion. The tentative outlook for 2010 shows a stabilising borrowing picture at around the level of USD 16 trillion. A looming additional challenge is the risk that when the recovery gains traction, yields will start to rise. Although there are signs that issuance conditions are becoming tougher, most OECD debt managers have been successful in financing the surge in funding needs. Less successful auctions can therefore best be interpreted as “single market events” and not as unambiguous evidence of systemic market absorption problems. The future could become more challenging though, given that rising issuance is occurring in tandem with increasing overall debt levels and debt service costs. In response, sovereign debt managers, with the essential support of the fiscal authorities, need to implement a timely and credible medium-term exit strategy to avoid future "crowding out" and systemic issuance problems, while reducing government borrowing costs.

Does Procyclical Fiscal Policy Reinforce Incentives to Dollarize Sovereign Debt?

This paper explores the link between the cyclical patterns of macroeconomic and policy variables and the currency composition of domestic sovereign debt in emerging market countries. The empirical analysis is anchored in an equilibrium model, in which the dollarization of sovereign debt arises as a result of the optimal portfolio choices by risk-averse investors, and of a sovereign debt manager who takes fiscal policy as given. The model predicts that in countries where the exchange rate is countercyclical (i.e., the exchange rate depreciates during recessions), a more procyclical fiscal policy (i.e., expansionary in good times and contractionary in bad times) would lead, on average, to a more dollarized domestic sovereign debt. The empirical analysis using the Jeanne-Guscina EM Debt database (2006) on the currency structure of the central government debt in 22 emerging market countries over 1980 - 2005, supports these predictions.