A new debt workout mechanism: the state of the debate early 2017 part 2

Principles and instruments for a better debt workout mechanism in the future

Hva som er oppnådd de siste 30 årene kan du lese mer om her i del 1.

The analysis of the shortcomings of debt renegotiations frameworks in the last 25 years has demonstrated that in order to avoid a repetition of the dire experience of the 1980s and 1990s a debt negotiation frameworks need to obey three basic principles of the rule of law:

• It needs to be comprehensive, i.e. negotiate all claims on an indebted sovereign in one single coherent process.

• It needs to lead to a decision about debt relief by an impartial institution, and

• that institution's decision must be based on an impartial assessment of the debtor's need for relief.

While the global financial crisis has indeed made the need for a "new deal on debt" ever more compelling, proposals from creditors and the powerful international financial institutions, have been technically useful at best and counterproductive at worst:

Since the demise of the SDRM Collective Action Clauses (CACs) have been at the heart of what creditors have suggested in order to make debt restructuring more efficient. Indeed, clauses, which serve to bind dissenting bondholders into majority decisions will be useful in the future. However, they refer only to one asset class - and sometimes only to one instrument in that class - while major coordination problems in the past have existed between rather than within asset classes.

The most useless proposal brought forward most recently in the G20 context is the extension of the Paris Club. This cartel of Western - and most recently some emerging market - creditors is much more part of the problem than of the solution, because it is exactly the prototype of creditors coalescing in order to judge over their debtors. The cases of Grenada and Dominica, Caribbean islands in debt distress due to their high vulnerability and being victim of a disastrous hurricane mid-2015, have most recently demonstrated that unchecked decision making power by such a cartel necessarily leads to biased outcomes saving creditors money, but reliably denying the debtor the opportunity for a fresh start. The Paris Club might eventually serve as a representation of their members as an asset class in a more comprehensive process; however, it must not play any role as a norm-setting body in a debt restructuring.

This inaction by those powers, who have traditionally guided debt negotiations in the past, has instigated debtors to seek a reform through global governance processes within their reach.

Most visibly, this has led to two processes in the United Nations system:

• UNCTAD's Roadmap and Guide for a Sovereign Debt Workout, which has taken up key elements of the above mentioned "traditional" proposals TIADS, FTAP, SDRM, adding a pragmatic guide for countries, which actually need to organise a debt restructuring in the context of the present crisis.

• A motion introduced into the United Nations General Assembly end-2014 which called on the UN to establish a sovereign debt workout mechanism in 2015. This process was driven particularly by Latin American members of the "G77 and China" group in the UN. It found unanimous support among all members of that group and was fiercely opposed by a small and shrinking group of industrialised countries, including all members of the G7 group. In the end, the process did not lead to a new framework, but only to the majority adoption of debt workout principles, which contain most of the key elements laid out above, but lacked any binding power.

Which way forward?

The experience of the 1990 teaches us that however undeniable the need for a far-reaching debt relief is, creditors will always try to postpone it as much as they can. This has ideological reasons like the all-to-welcome paradigm that "states do not go bankrupt", which was upheld before 2008. Even more is it due to creditor fragmentation, or, what Lee Buchheit calls "the temptation to kick the can down the road", i.e. hoping that each individual creditor will still be able to escape a sovereign default by dragging its resources out, while its costs will be borne by those remaining. While the 2004/5 UN process has demonstrated that creditors cannot be avoided, when it comes to designing a new framework, they cannot be expected to be pro-active.

A reform strategy therefore needs to build on two other key players:

• the United Nations system as a body that is not dominated by the entirety of creditor nations, as the Paris Club is, nor can be manipulated by individual debtors to the detriment of creditors;

• the individual debtors, who are in need of restructuring of their debt, and can indeed find fairer and more efficient ways and means than has been conceded to them through the creditor-dominated mechanisms, such as the Paris Club, HIPC, the Brady plan and others.

In order to inform practical next steps by these two key players, several suggestions have been made:

• Stiglitz/Guzman have extended the UNGA principles of 2015 into a soft law approach, refraining deliberately from establishing any binding legal standards, but trusting that the common good of an efficient restructuring process will serve to bind in a supermajority of creditors as well as the debtor.
• Establishing a "Debt Workout Institution" somewhere in the United Nations system, which can catalyse a roundtable process between the debtor and the entirety of creditors by facilitating this process, providing technical advice, hosting meetings and providing financing, where necessary. This proposal takes up much of the Dutch proposal referred to above - however on a formally non-binding basis.
• The design of regional or issues-based debt relief schemes. Such a scheme would deliberately refrain from designing a global mechanism. Instead it would build on the experience of the HIPC initiative, which demonstrated that it was possible to design a debt relief scheme for a more or less coherent group of countries while not affecting any others. The advantage of such a scheme would be that it could be elaborated in order to solve the most imminent debt problems of narrowly defined groups of countries, without having to consider side-effects on the rest of the world. Such country groups could for instance be the Caribbean SIDS, countries most affected by climate change or countries suffering from external shocks such as armed conflict in their neighbourhood and the resulting strong inflow of refugees. Of course, rule-of-law-based negotiation formats, which have demonstrated their capacity to resolve crises quickly and fairly would then also inspire more global reforms.
• The presently most attractive incentive for creditors to support reform could eventually be the need to counter the activities of vulture funds. Such rogue investors which buy distressed debt in order to sue for full payment plus fees and compound interest are not only a threat to the debtor, but also to bona-fide creditors, who see their generosity absorbed into competing creditors' pockets, and therefore to the functioning of debt relief at all. A comprehensive and rule-of-law-based mechanism would be the most effective prevention of such behaviour.