Based on extensive discussions among the participants, three topics were identified as focal points for the conference proceedings:
- How to improve the sovereign debt restructuring process, from initiation to completion;
- How to improve relationships between borrowers and lenders; and
- How to leverage innovative or repurposed financial instruments to enhance the effectiveness of debt restructurings.
The sovereign debt restructuring process, from initiation to completion
The pre-emptive phase
Notwithstanding indicators of imminent debt distress, borrowers often tend to delay approaching IFIs to request financial assistance or engaging with creditors to obtain a waiver, a bridge financing or a reprofiling of their financial obligations. This represents an impediment to the smooth resolution of temporary liquidity issues and generally results in a worsening of the crisis. Furthermore, it can aggravate the economic consequences of a debt restructuring once it becomes inevitable; compared to pre-emptive restructurings, debt restructurings following a default event take longer and can lead to a sharper decline in economic growth and investment as well as to a longer period of market exclusion.
This tendency to defer crisis response has multiple causes. Most notably, these causes include the borrower’s perception of a stigma connected to the request for financial assistance from IFIs, the fear of negative market signals deriving from consultations with creditors and the political costs associated with IFIs’ financial assistance programmes and debt restructurings.
In this context, the following measures could be considered further:
- The formation of neutral forums within which borrowers can seek advice and exchange experiences, such as advisory groups composed of former finance ministers or officials working in debt management offices of borrowing countries.
- A framework for regular engagement with creditors, especially private sector creditors, as a matter of best practice, building on the GSDR. The regularity of the exchanges would minimise the risk of negative market signals. Furthermore, once the indicators suggest a risk of distress it would allow creditors to formulate proposals for pre-emptive action, for example mobilising liquidity. The existence of a body representing private creditors could contribute to ongoing dialogue without the precondition of ‘urgency’ due to the situation at hand.
- Increase monitoring of the borrower’s economic situation by creditors.
The initiation phase
The initiation of a debt restructuring process depends on the borrowers. Typically, it involves borrowers’ engagement with the IMF to seek financial assistance, unless the country in distress is already in an IMF programme. Similar to the pre-emptive phase, the main challenge at this stage consists in the tendency to delay the request for financial assistance, due to perceptions of stigma and to the political costs involved. The following suggestions are advanced in this regard:
- Borrowers should consider hiring financial and legal advisers before approaching IFIs, whereas at the moment this is typically done afterwards. This would increase borrowers’ awareness of available options, including with regard to sources of financial and technical support, and enhance their agency throughout the process.
- The establishment of a regular and informal channel of communication with creditors would reduce the risk of delays.
The restructuring process
A majority of participants viewed the main challenges arising in the restructuring process to be: the sequencing and the timing of negotiations with IFIs and different sets of creditors, as well as transparency issues and inter-creditor equity concerns[1]. In particular, bilateral creditors generally require the prior negotiation of an IMF financial assistance programme before reaching an agreement on official debt treatment. However, the IMF Board’s approval of preliminary staff level agreements requires the initial implementation of economic reforms on the side of the borrower (prior actions) as well as the obtaining of financing assurances from the official sector. The latter element was viewed by many private sector participants as a source of major delays.
All creditors, in turn, are bound by the IMF’s DSA, which determines the overall restructuring envelope. However, some creditors, especially in the private sector, feel that there is a lack of transparency and meaningful creditor involvement in the formulation of the DSA, fostering perceptions of arbitrariness and uneven treatment of different groups of creditors. Permanent Paris Club members do not tend to share this view.
The role of the different actors involved in the debt restructuring process could be improved in various ways. In the view of most private sector participants, as regards the IMF, lack of trust and delays could be addressed through:
- The IMF’s engagement in consultations with all stakeholders, including private sector creditors, throughout the formulation of the DSA. While the final decision on the DSA remains with the IMF, such consultations would allow all stakeholders to offer their views on debt sustainability, increasing the transparency of the process and alleviating inter-creditor equity concerns.
- Encouraging the IMF staff to take the lead in securing financing assurances from official creditors. Shifting this task to the IMF staff following the negotiation of a staff level agreement would reduce the pressure on borrowers and arguably smooth and accelerate the final approval of IMF programmes.
Regarding official creditors, challenges and delays could be ameliorated by:
- Formulating and releasing best practices, including an indicative timeline for the key steps of the process, including, the formation of the official creditor committee following the negotiation of a staff level agreement, the provision of financial assurances, and the formulation of a MoU. Creditors should be required to provide updates on the process in case of material departures from the established timeline.[2]
- Clarifying that there is no necessary sequencing between official debt treatments and private sector debt treatments and encouraging early action from private sector creditors, including through adequate incentives such as flexibility margins in the comparability of treatment assessment.
- Maintaining that comparability of treatment should not be evaluated based on mathematical formulas. The comparability assessment should be sufficiently flexible to incentivise early action, based on the presumption that faster restructurings preserve more value for the borrowers and all stakeholders.
Regarding the role of private sector creditors, restructuring processes could be enhanced by:
- Proactive and early coordination among different creditor groups, which might allow reaching an agreement on private sector debt treatment prior to the final approval of an IMF programme.
- Creation of an entity representing private sector creditors on an ongoing basis in debt negotiations and other debt related matters. Such a group, similar in concept to the previous London Club but adapted to the current creditor and market landscape, would provide a voice for private creditors at all stages of the debt discussions, helping to address concerns around transparency and trust, while also potentially accelerating discussions and permitting more comprehensive and sustainable solutions for debtors and creditors alike.
- The identification and proposal of innovative or re-purposed financial instruments to
- manage the perceived challenges in the assumptions underlying the DSA; and
- mobilize new financing flows (e.g., through contingent instruments).
[1] It should be noted that a group of participants agreed to discuss and release, as a follow up action after the conference, a proposal outlining a timeline for debt restructuring processes and a set of principles concerning the responsibilities of all stakeholders involved. The proposal will be published soon.
[2] This measure has previously been suggested elsewhere but has not achieved a consensus on the part of all creditors.