Sovereign Workouts: An IMF Perspective

Abstract

I. INTRODUCTION Over the past several years, the international community has devoted considerable attention to improving arrangements for resolving financial crises and, in particular, for the restructuring of unsustainable sovereign debt. These efforts have benefited from the active participation of sovereign debtors, market participants, workout professionals, lawyers, economists and the "official sector," including the International Monetary Fund ("IMF"). As can be expected, perspectives regarding the dimensions of the problem and the direction of reform have varied. Nevertheless, a consensus appears to have been reached on two broad issues. First, there is a recognition that, in circumstances where a sovereign's debt has become unsustainable, all stakeholders-the sovereign debtor, its creditors, and the system more generally-will benefit from a restructuring process that is more rapid, orderly, and predictable than is currently the case. second, it is generally accepted that enhancing the effectiveness of the legal framework is critical to the success of any meaningful reform in this area. Much of the discussion has focused on whether the necessary strengthening of the legal framework can be achieved exclusively through private contract or, alternatively, requires official intervention, perhaps in the form of the IMF's proposed "Sovereign Debt Restructuring Mechanism" ("SDRM").1 Market participants have expressed concern that any form of official intervention would undermine the operation of capital markets in this area and, in particular, the quality of emerging market debt as an asset class. In contrast, the premise behind the SDRM has been that official intervention, if appropriately designed, would strengthen rather than weaken the operation of the international financial system. While recognizing the important limits of the analogy, supporters of official intervention have pointed to the critical role that domestic insolvency frameworks play in a market economy/ While there has been considerable support for the SDRJM within the official sector, efforts are currently underway to improve the restructuring process through market-based reform and, in particular, through a reliance on the collective action clauses that are found in international sovereign bonds. Whether the official sector turns its attention again to the SDRM will depend, at least in part, on whether these clauses are sufficiently robust to limit the severity of the costs that arise from the restructuring process. This article provides a brief overview of the key economic, financial and legal issues that have been central to the discussions in this area. section II identifies the problems faced by a sovereign and its creditors when the restructuring of the sovereign's debt becomes inevitable and, in that context, discusses the assistance the IMF can-and cannot-provide in these situations. Section III sets forth a brief analysis of the two primary proposals for legal reform: collective action clauses and the SDRM. section IV offers some concluding observations. II. THE PROBLEM While a sovereign debtor and its creditors share a common interest in an early and rapid restructuring of unsustainable sovereign debt, developments in the international financial system have conspired to make this a more complicated and time consuming process than it need be. In some respects, the problem is similar to the one confronted by a company and its creditors seeking to maximize value in an environment where debt structures are increasingly complex and creditor interests diverse. Of course, the corporate analogy only holds at a certain level of abstraction. There are a number of distinguishing features that have important effects on the process-most importantly, creditors and corporate debtors engage in the restructuring process in the shadow of liquidation.4 The "liquidation" alternative shapes not only the debtor-creditor relationship, but also the intercreditor dynamic, given the fact that a liquidation law defines the relative priorities among creditors. …