The Design of the Sovereign Debt Restructuring Mechanism

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  • INTERNATIONAL MONETARY FUND

    The Design of the Sovereign Debt Restructuring MechanismFurther Considerations

    Prepared by the Legal and Policy Development and Review Departments

    (In consultation with the International Capital Markets and Research Departments)

    Approved by Franois Gianviti and Timothy Geithner

    November 27, 2002

    Contents Page

    Introduction................................................................................................................................3

    I. The Rationale for the SDRM...............................................................................................4

    II. Principles Guiding The Design of the Mechanism .............................................................6

    III. Executive Summary of Key Recommended Design Features ...........................................8

    IV. Scope of claims covered by the mechanism....................................................................12 A. Identity of the Debtor............................................................................................13 B. Nature of the Claim...............................................................................................17 C. Identity of the Creditor Holding the Claim ...........................................................22

    V. Activation..........................................................................................................................25

    VI. Consequences of Activation .............................................................................................27 A. Provision of Information, Registration and Verification ......................................27 B. Stay on Enforcement .............................................................................................33 C. Contractual Provisions ..........................................................................................39 D. Other Consequences..............................................................................................41

    VII. Creditor Participation: Organization, Voting and Decisions.........................................42 A. Creditor Organization: The Role of Creditors Committees.................................42 B. Voting Thresholds .................................................................................................44 C. Priority financing...................................................................................................45 D. Restructuring Agreement ......................................................................................47

    VIII. Sanctions .......................................................................................................................54

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    IX. Termination........................................................................................................................56

    X. The Sovereign Debt Dispute Resolution Forum (SDDRF) .............................................56 A. Establishment of the SDDRF................................................................................57 B. Appointments to the SDDRF ................................................................................58 C. Organization of the SDDRF..................................................................................61 D. Powers of the SDDRF...........................................................................................66 E. Accountability and Transparency of the SDDRF..................................................70

    XI. The Amendment and its Consistency with Domestic Legal Systems ...............................70 A. Amending the Funds Articles ..............................................................................71 B. Consistency with Domestic Legal Systems ..........................................................72

    XII. General Conclusion ........................................................................................................73

    XIII. Issues for Discussion......................................................................................................74

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    INTRODUCTION

    1. This paper is a first step in responding to the request by the IMFC that the Fund develop, for consideration at the IMFCs meeting in April 2003, a concrete proposal for a statutory sovereign debt restructuring mechanism to be considered by the membership. Following the Boards consideration of the issues raised in this paper (which will be preceded by an informal seminar), a revised paper will be prepared, whichdepending on the outcome of the discussionswill include an initial draft of the text of the amendment to the Funds Articles. A report of the Executive Board to the IMFC would then be prepared in time for the IMFCs April 2003 meetings. Depending on the progress made by the Board on these issues, this report could include a revised draft of the text of an amendment and an associated commentary. Consistent with the approach that has been taken with earlier amendments of the Funds Articles, this commentary would eventually take the form of a report by the Executive Board to the Board of Governors.

    2. This paper focuses on a number of questions relating to the design of the SDRM. It does not discuss the broader range of economic, financial and policy issues that arise in the context of a restructuring of unsustainable sovereign debt, many of which will not be resolved through the establishment of the SDRM. These issues will be analyzed in a companion paper that will be circulated shortly after the Board discussion of this paper.

    3. This paper has benefited considerably from consultation with market participants and members of the judicial and legal professions. Consistent with the Boards request, the staff is intensifying its outreach efforts in order to build a consensus on the need forand design ofan SDRM. To that end, the Fund will be hosting a conference on the SDRM in mid- January 2003. Conference participants will include representatives of emerging market countries, key policy makers, market participants, academics and members of the legal and judicial professions. The feedback obtained from this conference will be taken into consideration in the preparation of the revised version of this paper and the initial draft of the text of the amendment to the Funds Articles.

    4. This paper is organized as follows. Distilling the analysis that has been developed during earlier discussions, Section I briefly discusses the rationale for the SDRM. Section II identifies a number of general principles that may provide useful guidance when resolving a number of the difficult legal and financial issues that arise when designing the mechanism. Section III contains an executive summary of the key design features of the SDRM. The scope of debt that could be potentially covered under the SDRM is discussed in Section IV. The conditions for activation are analyzed in Section V, while Section VI discusses the key consequences that will flow from this activation. Section VII discusses how creditors would participate in the restructuring process and, in that context, analyses issues relating to organization, voting and decisions, including the decision to accept a restructuring agreement. Section VIII discusses the various types of sanctions that could be considered to create disincentives for the abuse of the mechanism. The termination of the SDRM is discussed in Section IX. Issues relating to the establishment and powers of the Sovereign

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    Debt Dispute Resolution Forum are considered in Section X. Section XI addresses questions relating to the amendment process itself and the consistency of such an amendment with the domestic laws of members. Section XII sets forth a general conclusion. Issues for discussion are identified in Section XIII.

    5. The highlighted text in each section of the paper attempts to summarize the staffs preliminary recommendation as to how a specific feature of the SDRM could be designed.

    I. THE RATIONALE FOR THE SDRM

    6. On occasion, countries may experience severe financial difficulties as a result of major portfolio imbalances in one or more sectors of the economy. Clearly, in cases in which balance sheet difficulties extend beyond the sovereign, a resolution of financial crises and a return to sustainable growth will require that adjustments to a sovereigns debt burden be complemented by measures to restructure the banking system and/or to restore the solvency of the corporate sector. Moreover, to the extent that crises trigger capital flight, it may be necessary to make temporary resort to some combination of exchange controls and administrative limitations on the liquidity of bank deposits. Accordingly, by providing a framework that addresses the restructuring of sovereign debt, it is recognized that the SDRM would constitute only one element of a broader crisis resolution strategy, albeit a central one.

    7. In extreme cases, a sovereigns debt burden may be unsustainable. More specifically, members could confront situations where there is no feasible set of sustainable macroeconomic polices that would allow the member to resolve the current crisis and regain medium-term viability without a significant reduction in the net present value of the sovereigns debt. Judgments about sustainability, which involve an assessment a countrys capacity to keep its total debt under control without unrealistically large corrections in the balance between income and expenditure, underpin the Funds decisions in program contexts,

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