New Mechanisms for Restructuring Public Debt in Crisis Countries

The G10 group has also sought to prevent the above "vulture creditors" from impeding debt negotiations. This is achieved via provisions to the effect that only the representative of the bondholders may bring an action against the debtor or demand immediate repayment of the principal following, perhaps temporary, default on the part of the borrower (acceleration clauses). According to the G10 group, the bondholder representative can only be ordered to bring an action against the debtor by a group comprising at least 25 per cent of the bondholders. It is important to emphasise that most states raising bond loans in the international markets usually renounce certain of their sovereign privileges vis-à-vis the bondholders in the terms of the bond. Therefore bondholders may (jointly or individually) bring an action against the debtor in the court agreed upon by the parties to be the legal venue and may have the ruling enforced in the jurisdiction of the debtor state itself.

There is widespread agreement between official representatives and representatives of private lenders that it is important to promote the use of CACs on international financial markets (in January 2003 six private organisations^[9] tabled a similar proposal). In addition, the use of CACs in loan contracts does not in itself seem to make it more expensive for public borrowers to raise loans^[10].

It was therefore decided to launch various initiatives to ensure more widespread use of such clauses. In its surveillance the IMF recommended the use of bond issues with CACs, particularly by emerging market economies and developing countries, when new loans are raised. Industrialised countries could also set a good example when raising bond loans themselves. At the informal meeting of the ECOFIN Council in Copenhagen in September 2002 the authorities of the EU member states agreed to use such clauses when raising future loans under foreign jurisdictions. Denmark, which already includes CACs in the government's international loan programme, does not expect to issue government bonds governed by foreign jurisdictions in the near future.

In January 2003 Mexico issued loans in the US market with CACs, and in April 2003 Brazil, Uruguay and South Africa followed suit. This is the first time countries have introduced such clauses in the US market. In practice nearly all foreign issues in the USA, including those mentioned here, take place in the state of New York, which does not have a tradition for CACs^[11]. So far the pricing of these loans does not point to investors requiring compensation in the form of higher yields when the loan documents include CACs.

In international fora it is currently discussed how the G10 recommendations may be implemented in the international financial markets, and likewise it must be ensured that legislation in the most important financial markets (the USA, the UK, Japan, Germany and Luxembourg) does not prevent the intended functioning of such provisions.

It is acknowledged by all parties that increased use of CACs will not in itself, and particularly not in the short term, improve and ease negotiations on debt restructuring for sovereign states. Currently the greatest impediment is the fact that only 30 per cent^[12] of outstanding bonds are covered by such clauses. It will therefore take some time before all bond loans are covered. In addition, CACs have typically only applied to bondholders within the same bond loan. There have so far been no examples of all bondholders being covered by the same or by mutually agreed terms if a country has raised several bond loans (in technical, legal terminology: It is not possible to aggregate claims across the various loans). However, perhaps further development of the elements in Uruguay's rescheduling offer may in the long term lead to a sustainable solution to these problems.

A statutory debt-restructuring mechanism
These flaws in the contractual provisions, among other things, have led to the proposal for a statutory debt restructuring mechanism (SDRM, Sovereign Debt-Restructuring Mechanism). Such a mechanism would help to facilitate debt-restructuring negotiations and make them more transparent. The proposal has been discussed in a number of international fora, including institutions representing private lenders. The latter have, however, been sceptical towards instruments that will affect contractual freedom or creditors' entitlement to enforce their rights via national courts of law.

Basically the mechanism is structured in such a way that the authorities of the country may invoke the mechanism if the country should find itself in an acute balance-of-payments crisis. The authorities then convene the creditors and inform them of the country's problems and start to negotiate the terms of debt relief. A qualified majority of the creditors will be required to approve a debt-rescheduling scheme, and if a qualified majority approves the scheme it will be binding on all creditors. It will not subsequently be possible for a minority of creditors to bring an action against the country in question in order to achieve better terms than those acceptable to the majority of the creditors.

Four key elements of the SDRM discussions are outlined below.

What are the activation provisions?
There is general agreement that only the country's own authorities should be able to activate the mechanism and thus request renegotiation of the payment obligations as set out in the original loan contracts. The country hit by a balance-of-payments crisis convenes its creditors in order to explain its payment problems. At the same time the country is expected to submit a detailed overview of the economic-policy measures intended to remedy the payments problem. In this connection the approval of the IMF is of key importance, but under the proposal the IMF cannot directly decide whether the country may use the mechanism.

A qualified majority of creditors must be able to overrule the country's decision to activate the mechanism if they find such activation unwarranted or the terms offered unreasonable.

Which claims are to be covered and which are not?
It is of course especially in the interest of the country hit by a balance-of-payments crisis that the mechanism comprises as many of the country's creditors as possible; that the distribution of the burden is perceived to be fair; and that all creditors grant debt relief according to the same transparent rules. There are thus many arguments in favour of involving as many creditors as possible in the debt rescheduling.

There are, however, a number of obstacles that make it difficult for international organisations such as the IMF to generally recommend this principle. Firstly, the IMF's own rules impose an obligation on the members to respect the privileged status of the IMF's claims^[13], which are in principle to be repaid before other claims. The same applies to loans from the World Bank and many other international financial institutions.

Secondly, a well-established forum for restructuring debt to official creditors already exists, viz. the Paris Club^[14]. This informal circle of the industrialised countries' official creditors^[15] negotiates restructuring of loans to sovereign states. Other bilateral creditor countries are invited to participate in the negotiations on an ad-hoc basis. The Paris Club is an international forum that is not subject to any treaty, which enhances its flexibility when negotiating the various agreements. Restructuring concerns public loans (typically development loans) and publicly guaranteed credits (typically export credits). The Paris Club has regularly adjusted its principles and practices to reflect new developments. Debt restructuring within the Paris Club is thus based on an indispensable requirement for the debtor country to have entered into an agreement with the IMF on an economic-policy reform programme.

The results of the Paris Club's negotiations are set out in the "Agreed Minutes", which are not in themselves legally binding, but form the basis for the bilateral agreements which the creditor countries subsequently negotiate with the debtor countries. It is always the objective of the Paris Club agreements that other creditors should not obtain better conditions. In the almost 50-year lifetime of the Paris Club there have been virtually no examples of the creditor countries not observing the "Agreed Minutes". This negotiation format has proved to be an efficient instrument for getting results without undue delays owing i.a. to time-consuming ratification procedures in the creditor countries. On the other hand, the Paris Club format is difficult to include under an SDRM which by its nature is to be legally binding on all creditors in order to ensure that no creditors gain preferential treatment, and that creditors are prevented from taking legal action against the debtor.

The discussions of how the Paris Club creditors' claims can be covered by a possible SDRM have been put on hold temporarily. One reason is that the SDRM is aimed chiefly at countries raising large loans in the international financial markets where public and publicly guaranteed credits constitute only a minor part. These are typically medium-income countries, and not the poorest countries, which, depending on the concrete circumstances, can obtain very favourable concessionary debt-restructuring terms in the Paris Club^[16].

Likewise, private creditors might be even more sceptical towards the mechanism if the public creditors do not allow their own claims to be comprised by the scheme.

At an early point during the negotiations it was decided that the mechanism is not to comprise claims from the country's own citizens on the authorities in the country activating the mechanism. Such claims should be handled by the competent courts in the country in question, or in accordance with national procedures.

The discussions have been complicated further by the difficulties in laying down clear rules for how to respect creditors who have secured their claims via collateral in the debtor's assets.

A central element of bankruptcy legislation in many countries is the determination of one or more cut-off dates, where the legal effects of obligations entered into before and after this or these dates differ. So far it has not been possible to introduce similar provisions for determining cut-off dates in the SDRM proposal, nor to determine whether creditors providing loans after the activation of an SDRM procedure can avoidbeing covered by the SDRM or compulsory composition procedures. It should be noted that such dates may be highly significant for a country wishing to make use of the mechanism. The country may thus wish to keep up its economic steam and ensure that creditors providing trade credits to the country for essential imports are exempted from the mechanism. Such rules are, however, very difficult to implement across national borders and with sovereign states as borrowers; no supernational authority is competent to determine such cut-off dates. So far the mechanism is therefore based on the parties' ability to negotiate mutually acceptable solutions.

What role should the IMF play in the mechanism?
It is generally agreed that the IMF should not have any direct role in respect of either activating the mechanism or cancelling any such activation. The role of the IMF should primarily consist in preparing an economic-policy stabilisation programme for the country and analysing which debt level would be sustainable in the long term.

The IMF's lending to countries in arrears has always been controversial, precisely because the IMF is open to suspicion of favouring certain creditors, while the claims of other creditors are not repaid. The conditions for the IMF's lending to countries in arrears with their payments have recently been tightened by a "good faith efforts" requirement. For instance, such lending is now subject to the authorities of the country regularly informing its creditors of the country's situation and how it intends to resolve its payment problems. In addition, the authorities must state how they avoid favouring certain creditors.

There are also plans to set up a special debt resolution forum under the auspices of the IMF. This body will register the creditors' claims and ensure proper voting procedures and determination of voting results. Finally, a panel of arbiters in this "debt resolution forum" might be empowered to settle any disputes between debtors and creditors.

What should the legal foundation of the mechanism be?
Under the IMF's Article VIII, Section 2, the authorities in all member countries must respect restrictions introduced by a country and approved by the IMF and make exchange contracts which are contrary to such exchange-control regulations unenforceable in the territories of any member. It has been discussed whether this provision could in itself give the IMF the authority to require member countries to respect the outcome of an SDRM and thereby create a legal basis which would on the one hand force the courts to accept the decisions of the SDRM and on the other hand preclude creditors from taking action against debtors (who have activated the mechanism). The technical-legal assessment is that so wide-ranging an interpretation of this provision in the IMF's existing Articles of Agreement would be too uncertain. For instance, legal practice has demonstrated that courts in both the USA and the UK are unwilling to accept that creditors be precluded from taking legal action against a defaulting debtor who has a programme with the IMF. Owing to this considerable legal uncertainty there is agreement that an SDRM should either be implemented as an independent treaty or as an amendment to the IMF's Articles of Agreement.

If an SDRM is to be established by amending the IMF's Articles, this must be approved by three fifths of the members, having eighty-five per cent of the total voting power. The USA alone, which has approximately 17 per cent of the total voting power, is thus in a position to reject the proposal. The same can be done by a group of developing countries or emerging market economies comprising more than three fifths of the members (the countries defined as either emerging-market economies or developing countries according to the IMF's World Economic Outlook make up 154 of the IMF's 184 member countries).

Implementation of the proposal via an amendment to the IMF's Articles of Agreement will have the advantage that the SDRM provisions would be binding on all IMF member countries if the required majority is reached. An independent treaty solution, on the other hand, would only make the SDRM provisions valid in the countries acceding to the treaty.