Handling sovereign debt crises: a proposal

Handling Sovereign Debt Crises:A Proposal

January 2014

Richard Gitlin & Brett House

Senior FellowsThe Centre for International Governance Innovation (CIGI)

[email protected] [email protected]

Agenda

I. Context: relevance, diagnosis of problemII. An SDF: what, why, when?III. SDF focus: research, early consultationIV. Concerns and limits of the SDFV. Links with complementary approachesVI. Next steps

P. 2 │ Gitlin & House │ CIGI │ SDF

I.

I. Sovereign Debt Crises: Here to Stay

Easing of pressure in Europe, but…

• Advanced country debt burdens up 30 ppts GDP since 2008 to 105% GDP

• Global markets still highly correlated: risk on, risk off• Capital flows pro-cyclical, delinked from fundamentals• EMs vulnerable to Fed taper, stronger USD• Small island states cannot be made sustainable on existing

conventional Paris Club terms


I.

I. Problem: too little, too late

Costs to addressing sovereign distress:1. Ex ante2. In media res3. Ex post

Three major connected issues:4. Overlending and overborrowing5. Incentives to delay addressing insolvency6. Tendencies toward insufficient restructuring in market approach

• Not too much restructuring, too soon.• Reality: too little, too late.

• Need to lower cost of dealing with debt distress• Preserve value for creditors and debtors


I.

I. TLTL: Post-SDRM status quo doesn’t work

• Non-system does not optimize outcomes• Each crisis requires reinvention, delays, ad hoc-ery• Information flow is too slow, limited, asymmetric• CACs helpful, but can only do so much:

– They facilitate inter-creditor coordination– But they are reactive, not proactive– Do not bring together stakeholders early to find solutions– CACs are not a restructuring/bankruptcy regime

• Lessons from private debt restructuring:– Clear, transparent process: faster deals, greater preservation of value


I.

I. Greece is Not a Model

“The system needs to be fixed. We should have a predictable framework for restructurings that ensures that other countries do not have to go through what Greece did.”

— Petros Christodoulou, fmr head, Greek debt office

“I hope Greece was a one-off but I am not sure it was. If you look at all the debt out there it is hard to conclude that there isn’t a problem. State bankruptcies have not gone away. In fact they are likely to get worse.”

— Phillip Wood, Allen & Overy


I.

I. 7 Specific Issues to Address

Ex ante• Lack continuous effort to refine processes of dealing with

distressed sovereigns• No venue to bring creditors and debtors together proactivelyIn media res• Absence of an automatic standstill mechanism• Creditor moral hazardEx post• Pari passu thrown in doubt• Payment systems vulnerable• CACs are being circumvented


I.

III. An SDF: What is it?

Sovereign Debt Forum (SDF): Addressing ex ante costs• Non-statutory, uncodified but incorporated body• Neutrality in practice, venue and staff• Provides ongoing research, institutional memory• Standing discussion of surveillance, incipient crises, and,

when necessary, debt treatments• Transparent joint analysis of DSA, capacity to pay• Fair, balanced, and comprehensive representation• Dovetails with existing IMF and/or Troika processes• Learns from private sector experience


I.

II. Why an SDF?


Light:• Paris Club shows this type of ‘non-institution’ can be effective• EITI, APEC, GATT, CGAP, WEF precedentsPragmatic:• No political support for treaty- or statutory-based approachesComplementary:• Enhances existing processes and institutionsSupportive:• Aid other incremental improvements to debt treatment regime• Reduce trigger problem• Dampen political & creditor pressure on IMF staffFills gap• Dedicated to proactive treatment of sovereign financing issues

I.

II. An SDF: When?

Before 2008 crisis• 2002‒03: SDRM discussions fail• 2003: Wider introduction of CACs• 2003‒08: No demand for restructuring frameworkAfter 2008 crisis• 2010: Greece program; Merkel/Sarkozy - Euro SDRM• 2011: European CACs, EFSF/ESM, Greek debt exchange• 2012: Greek buyback• 2013: CyprusNow:• Crisis stabilized, can work on improving system• Status quo not a sustainable equilibrium

– Failure of Greek CACs– Exposure of NY payments system to holdouts by NML vs Argentina– Small island states cannot be restructured on conventional terms


I.

III. An SDF: How do we do it?

Creation• Incorporate as nonprofit organization• Informal secretariat at existing public institution• Expand existing body such as Paris Club, which has already

initiated outreach to new members through Paris Forum• Create stand-alone unit at IMF or BISInitiation• Build research on best practice, create institutional memory• Weave into IMF and/or European surveillance process• Assists in next sovereign workout: small island states (?)


I.

III. Expand on PC

Paris Club permanent membership


I.

III. More inclusive membership

SDFDebtor Sovereign

Creditor Sovereigns

Private creditors/

IIF

ILA

IMF

IIF

ISDA


III. SDF = early consultation

Growth & sustainability

Economic distress

Adjustment programme

Public financing

Debt treatment

Stakeholder consultation

Growth & sustainability

Public financing

Debt treatment

Stakeholderconsultation

SDF

Status quo

With SDF

Economic distress


I.

IV. Concerns & limits of the SDF

Not a panacea• Cannot enforce participation• Need to demonstrate incentives for involvement• Confidentiality necessary?• Neutrality possible?• Needs regular consultation to avoid trigger stigma• No forced stays, does not provide a standstill• No certainty in binding creditors

SDF proposed as a part of a menu of pragmatic, incremental reforms


I.

V. Complements existing principles

1/ IIF Principles• Transparency and timely flow of information• Close debtor-creditor dialogue to avoid restructuring• Good faith actions• Fair treatment

2/ Review of IMF Lending into Arrears Policy• Supports prompt Fund support• Venue for good faith efforts to reach collaborative agreements


I.

V. Pragmatic reform agenda

SDF plus…

1/ Define pari passu• Rule out ratable payments to nonparticipating creditors.

2/ Enhanced CACs with aggregation• Make aggregation more effective:

– lower threshold within issues (‘two-step’)– Institute comprehensive threshold across all debt outstanding (‘one-

step’)

3/ Immunize payments systems• Model legislation after Belgium/Euroclear protections

4/ Sovereign CoCos, indicator-linked warrants• Automatic rollovers, maturity extensions and contingent debt-service

reductions


Ex post

In media res

I.

VI. Next steps

Focus on ‘do-able’ reforms:• G20 deferral of issues to IMF• IMF Board paper in June 2014• Define model contractual language, adopt it• Issuance of contingent debt• Test SDF concept with small island states?


Handling sovereign debt crises: a proposal

Economy & Finance

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