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School of Law

The International Architecture for Sovereign Debt Restructuring

The Sovereign Debt Forum (SDF) was part of the IMF-African Training Institute Course "Debt Sustainability and Debt Restructuring (DSDR)”, which took place from 31 January - 3 February 2022.

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SDF scholar and Professor Lee Buchheit lectured on “The International Architecture for Sovereign Debt Restructuring” together with SDF scholars Professor Rosa Lastra, Professor Anna Gelpern, Professor Sean Hagan, and Professor Rodrigo Olivares-Caminal. On the second part, Professor Sean Hagan discussed on “How to Lessen the Pain: Legal Tools to Facilitate Sovereign Debt Restructuring”.

The International Architecture for Sovereign Debt Restructuring

Professor Lee Buchheit explained who are the lenders (sovereign debtor and state owned entities), and who are the borrowers (multilateral official, bilateral official, and commercial (private)). Professor Buchheit lectured on what categories of debt are excluded of the restructuring pool; i) trade credits, given the economic necessity of continued trade financing, ii) senior or collateralized debt obligation, iii) Treasury bills, given the need for continued short-term financing of the government, and, iv) the claims of international financing institutions, such as IMF and WB.

He emphasized the principal international forum for restructuring official bilateral claims is the Paris Club, an informal group of 22 creditor countries whose aim is to to find coordinated solutions to sovereign debt problems.

Professor Buchheit further described the toolbox of a sovereign debt restructurer. In the first place, a sovereign may change the maturity dates for amounts of principal or interest falling due under the affected debts. In the second place, it may introduce grace periods. In the third place, it may reduce the principal amount of the debt (“a principal haircut”), and finally, it may reduce the interest rate on the debt (in the case of bond indebtedness, a “coupon adjustment”, which resembles the old days when physical coupons were delivered to creditors.

How to Lessen the Pain: Legal Tools to Facilitate Sovereign Debt Restructuring

On the second part, Professor Sean Hagan lectured on the sovereign debt resolution Framework. He described the ways to encourage creditor participations via carrots and sticks. The first sweetener is cash or a cash equivalent, like high-quality short-term debt obligations of a third party. A second sweetener is the “Value Recovery Instrument” like GDP-linked instrument, or instruments that give warrants linked to the price of oil. A third sweetener is the principal reinstatement feature, which provides that if a debtor country seeks to restructure the same debts in the future, the lenders would maintain their original claims unimpaired. A forth sweetener is the “Parity of Treatment Undertakings”, which is a covenant promising that other lenders will not be given preferential treatment. A fifth sweetener is the Credit Enhancement, which ensures a third party to issue a partial guarantee of amounts due under the new bonds. A sixth sweetener is the use of contractual improvements, which involves upgrade in contractual terms, e.g. no submission to the jurisdiction of local courts.

On the stick side, he explained the existence of:  i) Implicit or Explicit Threats of Nonpayment; ii) Collective Action Clauses, which enable a qualified majority of bondholders of a specific bond issuance (typically 75 percent) to bind the minority of the same issuance to the terms of a restructuring;  iii) Exploiting the Local Law Advantage, that is threatening to change the local law to facilitate the debt restructuring; iv) Exit Consents, which are consents to modification to the old bond that would make it less attractive to prospective holdout creditors; v) use of trust structures; and, vi) protection of sovereign assets.

Professor Hagan examined the “5 steps” of the Sovereign debt Resolution Framework. The first step consists of the loss of market access of the sovereign debtor, where it finds no adequate demand for its debt supply. Step 2 is when the sovereign debtor approaches the IMF for financing. If the debt is sustainable, then it will ensure a catalytic program. However, if the IMF determines that debt is unsustainable (Step 3), it specifies the “restructuring envelope” and it will determine the overall quantum of needed debt relief. Step 4 consists of the Debtor negotiating with creditors on a restructuring consistent with the “envelope”. If necessary, IMF activates lending into arrears policy. Finally, Step 5 is the activation of collective action clauses (CACs) to bind all creditors.

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