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IMF - Sovereign Debt Restructuring Mechanism
Wed Sep 25 23:34:14 2002
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Public Information Notice (PIN) No. 02/106
September 24, 2002
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Board Discusses Possible Features of a New
Sovereign Debt Restructuring Mechanism

On September 4, 2002, the Executive Board of the International Monetary
Fund (IMF) continued its discussions on the possible features of a new
Sovereign Debt Restructuring Mechanism (SDRM), focusing on the
treatment of different types of sovereign debts and the design of a
sovereign debt dispute resolution forum.1

Background

The IMF, as part of its ongoing work on crisis prevention and resolution,
has begun a discussion on how to help countries with unsustainable debts
resolve them in an orderly manner. Emerging markets have benefited in
recent years from the availability of wider sources of finance. However, the
diverse nature of the creditor community of bond holders can be
troublesome when debt has become unsustainable and has to be
restructured.

The Fund is considering two complementary approaches to creating a
more orderly and predictable process for sovereign debt restructuring: (i) a
contractual approach, in which debt restructurings would be facilitated by
enhanced use of certain contractual provisions in sovereign debt contracts
and (ii) the establishment of a universal statutory framework which would
create a legal framework for collective decision making by debtors and a
supermajority of creditors.

Against this background, the Executive Board discussed a paper,
"Sovereign Debt Restructuring Mechanism-Further Considerations," that
provided a preliminary discussion of two central issues in the design of the
SDRM. They are the scope of the debt that the SDRM will cover, and
how included claims are organized for voting purposes.

Because creditors of the sovereign have different types of the claims and
may not be similarly situated, it would be difficult to aggregate all claims on
the sovereign into a single vote. Consequently It would be appropriate to
establish a system for classifying claims into classes for voting purposes.
The approval of a super-majority of each class would be needed to
complete the restructuring. The paper focused specifically on whether to
include domestic debt, defined as debt governed by domestic law and
subject to the jurisdiction of domestic courts, and official bilateral debt in
the SDRM as separate creditor classes, or to exclude these categories of
claims from the SDRM. Establishing a statutory SDRM through an
international treaty also would allow for creation of a single and exclusive
dispute resolution forum that ensures legal uniformity in all jurisdictions and
uniform interpretation. The paper provides a discussion of possible features
of such a dispute resolution forum.

Executive Board Assessment

At the conclusion of the Board meeting, First Deputy Managing Director
Anne Krueger made the following remarks:

"We have had a constructive and thoughtful discussion of possible features
of a new Sovereign Debt Restructuring Mechanism focused on the
treatment of different types of sovereign debts and a sovereign debt
dispute resolution forum. The views expressed today will help shape the
development of the mechanism, and provide valuable guidance to the staff
for future work. There is broad support among Directors for a statutory
debt restructuring mechanism, as well as a development of collective action
clauses, to improve the international financial architecture.

"Most Directors reiterated the view that the current process for the
restructuring of sovereign debt is more prolonged, more damaging to a
debtor and its creditors, and more unpredictable than is desirable. They
welcomed the opportunity to give further consideration to a possible
mechanism that could provide incentives for a debtor with a clearly
unsustainable debt burden, and its creditors, to reach rapid agreement on a
restructuring that helps pave the way toward a return to fiscal and balance
of payments sustainability. They considered today's discussion, following
the earlier one on collective action clauses, to have been a further
important step in examining the legal, institutional, and procedural aspects
of the two proposed approaches to sovereign debt restructuring.

"Directors observed that debt restructuring is only one element of a
comprehensive framework for resolving a member's problems, and that the
need for continuing support from the Fund during the restructuring process
is important for orderly economic adjustment. Some Directors stressed
that care should be taken to ensure that an eventual SDRM does not lead
to restructurings that might have been avoided with continued adjustment
and more temporary official financing.

Scope of Debt Covered by the Mechanism

"Directors welcomed the opportunity to discuss the complex issues
associated with the scope of debts that could be covered by an SDRM,
and the ways in which the restructuring of different types of debt could be
coordinated.

"Directors agreed that the scope of debts that might need to be included in
a restructuring should be sufficiently broad, so as to secure an adequate
reduction in the debt and debt-service burden and to achieve sufficient
intercreditor equity to garner broad support for a restructuring. They
considered that the coverage of individual restructurings would need to be
decided by debtors in light, inter alia, of the willingness of the Fund to
support a program based upon such a restructuring and the ability to reach
agreement with creditors.

"Directors underscored that the potential complexity and diversity of both
instruments and creditors highlight the need to allow flexibility in the design
of the SDRM. As creditors may have different types of claims on a
sovereign and may not be similarly situated, Directors noted that it would
be difficult to aggregate all claims on the sovereign for voting purposes into
a single vote. Accordingly, Directors indicated that the establishment of a
classification system whereby claims are aggregated within—but not
across—classes for voting purposes would be appropriate. Directors also
noted that such a system could facilitate restructurings by enabling the
debtor to offer different terms to different classes of creditors based on the
different nature of the claims held by the class in question as well as their
particular preferences. The classes should be made sufficiently broad and
their number kept to a minimum; the approval of each class would be
required to complete the restructuring, giving each class an effective veto
over a restructuring done through the SDRM. Most Directors considered
that, in order for the SDRM to adapt to the evolution of the capital
markets, it might not be desirable to pre-specify all of the classes in the text
of the treaty establishing the SDRM. Some Directors noted that the
existence of veto power could prolong the debt restructuring process, and
suggested that care be taken to ensure that the classification process does
not create potential hold-out problems.

"Directors also considered that the mechanism would not necessarily need
to encompass all sovereign obligations for it to provide an effective
framework for coordinating a comprehensive restructuring. They were in
favor of keeping the mechanism simple and tightly confined to addressing
specific problems that may cause difficulties for sovereign debt
restructuring. In particular, they considered that types of debt that can be
restructured without giving rise to severe collective action difficulties could
be excluded from the mechanism without jeopardizing the authorities'
ability to restructure such claims. They noted though, that it would be
important to include those debts for which the SDRM would provide the
sovereign with effective tools to overcome collective action difficulties.
Directors agreed that sovereign debts governed by foreign law or under
the jurisdiction of foreign courts would need to be covered by the
mechanism in order to allow the sovereign to use the tools for addressing
collective action difficulties.

Domestic Debt

"With regard to domestic debt, Directors emphasized the need for
considerable caution in the design of restructurings, particularly with a view
to paving the way toward a relatively rapid return by the sovereign to
domestic capital markets and preserving at least a core banking system.
Directors noted that domestic debt restructuring would also have
implications for monetary control, and that a program's reserve floors and
monetary targets would play a crucial role in determining the scope of the
domestic debt restructuring that would be needed.

"Regarding the treatment of domestic debt under the SDRM, Directors
agreed that governing law and the jurisdiction of the claim provided the
best basis for distinguishing domestic debt from foreign debt. For sovereign
debts governed by domestic law and subject to the jurisdiction of domestic
courts, most Directors considered that members already have adequate
tools for restructuring such instruments, and that they should be excluded
from the SDRM at least initially, though consideration could be given to
establishing a procedure that would allow the coverage subsequently to be
extended. A few, however, considered that there would be benefits in
ensuring that the SDRM is comprehensive, and thought that domestic debt
should be included, albeit as a separate class, and that the consequences of
policies on the value of credit denominated in local currency be taken into
account in any restructuring of external debt. A number of Directors noted
that the Fund should avoid encouraging sovereign debtors to use its
sovereign powers to unilaterally restructure domestic claims unless an
overall restructuring process is in place that has the support of the
international community.

Official Bilateral Debt

"Directors reiterated their view that the Paris Club provides an effective
and flexible mechanism for restructuring claims of official bilateral creditors
and mobilizing support from such creditors for members' adjustment
programs. They cautioned that considerable care would be required in
addressing relations between the SDRM and the Paris Club in order to
preserve the Club's ability to provide early support, while providing the
flexibility needed to address intercreditor equity concerns in the more
complex cases in which both private and official bilateral creditors have
substantial exposure. Some Directors considered that it is premature to
form a firm judgment of the treatment of official bilateral debt under the
SDRM before they had the opportunity to hear the views of Paris Club
and other official bilateral creditors. Some Directors, however, considered
that there were substantial benefits in including official bilateral creditors
within the SDRM as a separate class. Some Directors also noted that the
claims of non-Paris Club bilateral creditors would need to be taken into
account in designing the SDRM. Nevertheless, the preliminary view of the
Board was that official bilateral claims should be excluded from the
SDRM, at least initially, but that close coordination would be needed

• A Bleak picture from the IMF? — Lisa Thomas, Thu Sep 26 01:54