Value Recovery Instruments: A Contrarian Proposition

Abstract

• Value recovery mechanisms are a subset of sovereign state-contingent debt instruments (SCDI). Within this category is a further subset: the freestanding value recovery instrument (VRI). This is a restructuring tool that has typically been either geared to a single factor trigger (such as petroleum prices) or a broad macro trigger (GDP). It is constructed in order to trade freely from the outset or is detachable from the related restructuring credits over time. It is designed to compensate creditors for granting debt reduction in the restructuring process. • Recent history has not been kind to VRIs. This promising mechanism in its current iteration has attracted negative feedback from the market and negative reviews in academic and policy circles. The primary focus of this bad press is the difficulty in valuation due to complexity, lack of standardization and perceived flaws in structure. And the lack of benchmarks for normal market SCDIs has contributed to the problem. Curing these deficiencies is thought to help to resolve the valuation issue. • The article contends that valuation, already a challenge, is further complicated by tradability as, among other factors, it adds another party to the table beyond debtor and creditor—the third-party secondary market participant. The article further elaborates upon other problematic results of the tradability feature of the VRIs. • A set of measures is proposed to improve the value of VRIs and to eliminate additional negative consequences with the aim that the VRI will benefit both creditor and debtor interests. • Recognition is given that the proposal sets a very high bar for the use of VRIs in pure bond restructurings but that those cases have proven to be problematic for debtor and creditor alike. In this connection, the article notes that a number of countries have no or a limited amount of bond exposure and that the proposed strategy may have its most important impact in that context.