Looking Forward: 2005-2010 - a Sovereign Debt Restructuring Reverie

In a prior article, the author asked why, if a sovereign debt restructuring treaty would be effective and easy to implement, one does not yet exist. There appeared to be at least three reasons: the very novelty of the approach; the opposition of interest groups who believe that a treaty approach would make it too easy for sovereign debtors to default; and the failure of parties to appreciate the importance of a treaty approach, coupled with concern over ceding sovereignty. In this short reverie, the author hopes to show that these reasons are flawed and that, even where bond issues already include collective action clauses, a treaty approach would benefit both debtor-nations and their creditors. The room hushed as Premier Gursky walked in. Gursky glared at his ministers, finally focusing on Yosef Steif. As Minister of Finance, Steif knew what was coming. "Trans-Ptomaineia is rapidly exhausting its foreign reserves, and I fear we will have no choice soon but to default on our bonds," said the Premier. "I want you, Minister Steif, to examine our options and to report back within two days. If we default, or if we restructure our debts unilaterally, our nation will suffer grave reputational costs in the world financial community."2 Steif immediately set his staff to explore the sovereign debt restructuring options. The computers were temporarily down-"damn, a decade after Y2K and still there are bugs in the system"-so staff members actually had to start their research in one of their country's few remaining libraries. Twenty-four hours later, the staff reported back with two possible approaches: one depending solely on privately negotiated agreements between their nation and its creditors (a "contractual approach"), the other based on a public international law convention, or treaty, among nations (a "treaty approach"). Under the contractual approach, for each bond issue requiring individual bondholder approval to change essential payment terms (such as the amount of principal, the rate of interest, or the maturity schedule), Trans-Ptomaineia would offer bondholders the option of exchanging their existing bonds for new bonds having less stringent payment terms-terms that Trans-Ptomaineia could manage to pay. To induce as many bondholders as possible to agree to this exchange, exchanging bondholders would be asked to waive various protections in their bond indentures that can be waived without unanimity, such as cross default and negative pledge covenants. Bondholders not agreeing to exchange then would find these contractual protections gone if a sufficient majority of other bondholders consent.3 Years ago, Ecuador was reported as having used this strategy,4 although its bonds may have lost about 40 percent of their net present value as a result.5 On the other hand, approximately half of Trans-Ptomaineia's existing bond issues did not require individual bondholder approval to change essential payment terms. These bond issues included "collective action clauses,"6 allowing even payment terms to be changed through "supermajority voting."7 For these issues, it would be easier to agree on debt restructuring terms with creditors because, if and when the relevant supermajority of bondholders agreed to terms, their agreement would bind any objecting bondholders. The treaty approach to sovereign debt restructuring, Steif learned, would rely on a newly-opened treaty among States, based on a model developed in 20008 and later proposed by the International Monetary Fund (IMF).9 A debtor State taking advantage of this treaty would agree to conduct its economic policies so as to put itself back on the road to viable growth, in exchange for which the treaty would give priority to repayment of new private moneys loaned to the debtor State. The treaty also would empower the debtor State and a supermajority of its creditors to approve a restructuring plan, which would bind all creditors, notwithstanding the objections of holdouts against whom the plan did not discriminate. …