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January 21st, 2020

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Futurist Landscape

REMEDY EXERCISE

Legal frameworks for sovereign debt restructuring

Despite contributing towards a series of crises (from the third world debt crisis of the 80s to the Euro-crisis of 2010), sovereign debt is rising across low-, middle-, and high-income economies, leading to renewed discussions around the macroeconomic consequences of sovereign debt restructuring and default.

In addition to debates about the economic consequences of default, a large academic and policy literature explores the varying legal architectures of debt contracts. In a 2002 paper, LEE BUCHHEIT and G. MITU GULATI present a history of contractual provisions for sovereign bonds in the United States, focusing specifically on the absence of collective action clauses, which are mandated in the UK.

From the article:

"In most contracts, the parties know each other's identity beforehand, and they make a conscious decision to enter into a legal relationship. In a multi-creditor debt instrument, the borrower's identity is of course known by each investor, but what the investors don't know is the identity of each other. When the bond issuer runs into financial difficulties, the actions of any one bondholder can dramatically affect the interests of all the other lenders.

Bonds issued by both corporate and sovereign borrowers in the early nineteenth century rarely contained provisions that contemplated collective decisionmaking by the bondholders. Each bond was a freestanding debt instrument; its terms could not be changed without the consent of its holder, and, if not paid when due, each holder was free to pursue her individual remedies against the issuer. The instruments did not require a holder to consult with, much less to act in concert with, fellow bondholders before, during or after a default. Although this approach ensured that each bondholder's claim against the borrower could not be deranged without that bondholder's consent, it also had the consequence of forcing financially-distressed corporate borrowers into bankruptcy (which in those days meant liquidation). This was, is, and ever shall be the "holdout creditor problem" in a debt workout.

One hundred years on, the financial community is again confronted with a remarkably similar problem. A sovereign bond issuer of the early twenty-first century is in much the same spot as the distressed corporate or railroad bond issuer of the early twentieth century. The merits of including majority action clauses in sovereign bonds as a method of neutralizing the holdout creditor are being proposed in some circles today, just as they were in the 1920s and 1930s in the context of corporate bonds. It may be feasible to engage the equity powers of U.S. federal courts in the oversight of some sovereign bond workouts with the result that the bondholders can be homogenized into a single voting class, and any court-approved compromise of the action will bind all members of that class."

Link to the paper.

  • "By noticeably intensifying distributional conflict over scarce public resources, sovereign debt crises tend to lay bare underlying power dynamics that, during normal times, are quietly at work beneath the surface." Jerome Roos's recently published book uncovers the global distributional politics underlying the financialization of sovereign debt. Link. See also Barry Eichengreen's 2003 comparative overview of debt restructuring proposals. Link.
  • Two pieces by José Ángel Gurría on the recent history of Mexico's debt crises: from Coping with Capital Surges, a chapter on the historical trade-offs of foreign direct investment; and a 1995 paper on "The Mexican Debt Strategy" draws policy lessons from the crises of the '80s. Link, link.
  • "The Greek debt restructuring of 2012 stands out in the history of sovereign defaults. It achieved very large debt relief—over 50 per cent of 2012 GDP—with minimal financial disruption, but it did so at a cost." From 2013, "An Autopsy" of Greek debt restructuring, by Jeromin Zettelmeyer, Christoph Trebesch, and Mitu Gulati. Link. And a 2014 paper by Miranda Xafa assesses the drawbacks to delaying the restructuring after mid-2011. Link.
    h/t reader Dominik L for several of these links
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