Sovereign external debt workout: the political economy of the UN resolution
On 9 September, 2014, a large majority of member States mandated the UN to create a “multilateral legal framework for sovereign debt restructuring”. The resolution (A/68/L.57/Rev2) commits the General Assembly to agree on modalities, or the terms and logistics, for commencing open, intergovernmental negotiations on a sovereign debt restructuring framework by the end of 2014. Subsequently, the resolution commits governments to adopt an outcome on a “multilateral legal framework for sovereign debt restructuring processes” by the end of the 69th session of the UN General Assembly (by about September 2015). Of 193 UN member States, 176 showed up; 124 voted in favour, 41 abstained, and only 11 voted against the resolution.
The resolution was triggered by the aggressive vulture funds lawsuits against Argentina (NML Capital vs. Argentina) at a provincial court in the US state of New York. Judge Thomas Griesa ruled in favour of the NML Capital, “vulture fund” holdout creditors who bought Argentina’s debt from 8% of its bondholders at a significant discount when in 2001 Argentina took the unusual step of unilaterally defaulting on its entire $100bn debt, but refused to accept any losses when the government negotiated a debt swap in 2005 at a 70% "haircut". The court ruled that Argentina could not pay the 92% of creditors who accepted big reductions in the amount they were owed unless it also paid the litigant “holdouts” the full value of their original claims plus interest.
The ruling can be seen as a victory for the rule of law. However, the triumph of the litigious minority comes at the expense of the majority who accepted the restructuring. Moreover, this sets a precedent that would probably encourage more and lengthy hold outs making the prospect of debt restructurings unpredictable. In particular, sovereign debt crises involving bonds issued under American law will become harder to resolve. The frequency of debt crises since the Latin American debt crisis in the 1980s has made it clear that cyclical debt crises will continue. Due to unavoidable consequences of a delayed insolvency filing the world will pay a high price in terms of deepening social and economic polarization through unpleasant adjustment processes as well as unnecessarily high losses to investors.
However, by interpreting the pari passu (equal treatment) clause in an extraordinary way Judge Thomas Griesa has created an unintended side-effect. This landmark UN General Assembly (UNGA) resolution is hugely significant as it could be a game changer for the way future debt crises are managed. This potentially plugs an important hole in the international financial architecture. The lack of a legal framework for sovereign debt restructuring – a state insolvency regime – has been a gaping hole in the international financial architecture.
Demand for an orderly, timely, fair, transparent and predictable sovereign external debt workout mechanism is not new. Various proposals for a sovereign debt workout mechanism have been around for quite some time.[i] They received renewed emphasis since the early 1980s in the wake of the Latin American debt crisis. The issue has slipped off the international public policy debate due in part to the agreement and implementation of international debt relief schemes such as the Heavily Indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI). The debate resurfaced in the aftermath of 1997-98 Asian financial crisis.
However, past initiatives were stalled as developed country governments argued that it was not the right moment for a reform. Surprisingly the attitude of developed country governments has not changed even when a good number of developed countries, especially the euro-zone ones, are suffering from debt crisis; they either voted against the UN resolution or abstained. This time, they argued that the UN is not the right place to deal with this issue; it should be left to specialized organizations, such as the International Monetary Fund (IMF) or the G20 processes. The US, in particular, argued that collective action clauses and a contractual approach to debt disputes settled in the courts of the country whose laws govern the contract were enough and there was no need for regulation on a statutory level. Interestingly, there is no explicit wording for a statutory approach in the resolution.
Developing country solidarity
Argentina’s bold move of proposing a UNGA resolution was backed by all G77 countries and China. Almost all developing countries, including the Africa Group countries and the Small Island Development States (SIDS) voted in favour. This solidarity has been unprecedented. The absence of some developing countries (Cameroon, Cambodia, Central African Republic, Ghana, Lesotho, Somalia, Liberia, Mali, Micronesia, Marshall Islands, Nauru, Republic of Macedonia, Timor-Leste and Tuvalu,) did not necessarily reveal their reservations or lack of interest. For example, some Pacific Island countries could not attend due to recently concluded SIDS conference in Samoa which took place a few days before this resolution was debated. All BRICS countries (Brazil, Russia, India, China and South Africa) voted in favour of the Resolution. This reflected widespread dissatisfaction of developing countries and emerging economies with the stalled reforms of the IMF.
Crack in the developed country camp
This time around the objections of developed countries to the multi-lateral initiative for a legal framework for sovereign debt workout mechanism do not seem to be uniform. For example, contrary to the usual pattern of bloc voting, the European Union (EU) not only voted as separate member States, but also their voting pattern varied markedly. The United Kingdom and Germany, followed by Ireland, Finland, Hungary and the Czech Republic voted against the resolution, while Italy, France, Sweden, Switzerland, Netherlands, Spain, Greece, Norway, Portugal, Denmark, Austria, Bosnia and Herzegovina, Bulgaria, Cyprus, Latvia, Lithuania, Luxembourg, Malta, Monaco, Montenegro, Serbia, Slovakia, Slovenia, Ukraine abstained. Such an explicit division within the EU vote is unique compared to the EU position in other development finance and global institutions.
The country grouping of Japan, United States, Canada, Australia and New Zealand, led by the United States, was also divided. For example, New Zealand abstained from a vote and the United States was the only country in the group that explicitly rejected the very prospect of negotiating for a multilateral legal framework. Canada and the other countries in the group did not explicitly reject intergovernmental negotiations. This in fact isolates the United States as the most serious obstacle to ensuring the minimum political space to allow for intergovernmental discussions within the UN.
Sovereign debt restructuring and the IMF
The IMF has been working on the design of an orderly sovereign debt workout mechanism for quite some time. After the Asian financial crisis, the IMF’s former First Deputy Director Anne Krueger took the initiative to design an orderly sovereign debt workout mechanism to fill a serious deficit in the international financial architecture. The IMF Board recognized that countries facing debt servicing difficulties should first seek voluntary agreement with the debtors on temporary standstills.[ii] The Board was also willing to provide support to countries imposing standstills and restrictions by “signalling the Fund’s acceptance of a standstill … through a decision … to lend into arrears to private creditors.”
Thus, in 2002, the IMF worked on a two-track approach to improving sovereign debt restructuring, known as Sovereign Debt Restructuring Mechanism (SDRM).[iii] The first track involved more ambitious use of collective action clauses in sovereign bond contracts. The second – and complementary – track involved creating a statutory mechanism that could help secure more orderly and timely restructuring of unsustainable sovereign debts by empowering a super-majority of creditors to take key decisions in the restructuring process in negotiation with the debtor in case there was a hold out. This was akin to internationalization of US bankruptcy law, in particular chapter 11.
Yet, the IMF failed to get an agreement in the face of opposition from some major developed countries and pressures from financial markets. This was despite excluding the provision of statutory protection to debtors in the form of a stay on litigation and considerable leverage given to creditors in granting seniority to new debt.
In the wake of recent debt crisis in the euro-zone countries, the IMF has proposed a less ambitious mechanism for sovereign debt restructuring or reprofiling.[iv] The proposal contains two changes to its lending rules. First, it wants greater leeway to support the “reprofiling” of sovereign debt. Reprofiling is a relatively gentle form of restructuring, in which the maturity of bonds is extended but the amount owed and interest rate stay the same. Second, it also wants to get rid of “systemic exemption” to its lending rules, introduced during the euro crisis, to limit the risk of being pressed into lending huge amounts to stave off default in a country whose debts are unlikely to be sustainable. This exemption tolerates large loans to countries that are poor credit risks, but are important enough to pose a threat to the global financial system.
The proposed new plan, although less ambitious than the 2002 SDRM proposal, is yet to be approved by the IMF Board subject to further in-depth studies. According to Hugh Bredenkamp, Deputy Director of the IMF’s Policy, Strategy, and Review Department, it could be a year or so before the IMF’s Board is ready to consider possible modifications to Fund policies with regard to sovereign debt reprofiling. If and when approved, they would simply lead to more equal treatment for would-be borrowers and, at the margin, might encourage more countries to reprofile their debts earlier.
It should be noted that even an SDRM-type solution would be inadequate for developing debtor countries as there would be no debtor protection, no guarantee of human rights standards, no voice of those affected and would firmly put one or several (most likely public) creditor(s) in the driver’s seat. Moreover, various IMF lending facilities to help countries having difficulties servicing their debt usually carries pro‐cyclical conditionality in an effort to restore creditors’ confidence and to secure debt sustainability. However, such pro-cyclical conditionality often inflicts high social and economic cost, while investor confidence may not get a boost if growth falters due to the very conditions. Thus, what may have been a liquidity crisis can turn into a solvency crisis. Additionally, multilateral, including IMF lending to debt distressed countries is often designed to keep debtors current on their obligations to private creditors and maintain an open capital account, again to maintain investor confidence, instead of financing imports essential to maintain income, investment and employment.
Here lies the significance of moving the issue out of IMF. Debt restructuring is simply too important to be left to the IMF. The developing countries do not have a significant stake in the IMF’s Board, and as a major creditor, the IMF would have a serious conflict of interest. By entrusting the UN for the first time to design a legal framework for sovereign debt restructuring, the debtor nations have now finally taken the driving seat.
Is UN the right forum?
As mentioned earlier, developed countries expressed reservations about the suitability of the UN for dealing with sovereign debt issues. However, developing countries made it clear that the UNGA is the most inclusive forum, and hence the right place for political debate and decision-making to take place.
Moreover, the discussion of financial system issues such as financial regulation, the international monetary system, and in particular, sovereign debt, regularly takes place in the UN. For example, the Second Committee negotiates a resolution on debt sustainability which is adopted by the General Assembly every year; and the Economic and Social Commission (ECOSOC) holds an annual conference with the Bretton Woods Institutions in which sovereign debt is prioritized through the HIPC initiative and MDRI governed by the World Bank and IMF. Various UN conferences, such as the 2002 Monterrey Conference on Financing for Development and 2008 follow-up Conference in Doha, 2009 World Financial and Economic Crises and its Impact on Development and 2012 Rio+20 Conference, clearly mandated the UN to deal with sovereign debt issues.
As a matter of fact, the UN secretariat has already set up expert groups on new debt workout mechanisms at the United Nations Conference on Trade and Development (UNCTAD) and the UN Department of Economic and Social Affairs (DESA). UNCTAD expert group, which has been working on principles for a debt workout mechanism as well as guidelines for responsible sovereign lending and borrowing, has produced several proposals for effective and fair debt workout mechanisms.[v] The UNCTAD expert group has agreed at its last meeting that the principles of legitimacy and impartiality would be important for a debt workout mechanism. Other principles discussed at earlier expert group sessions included efficiency, sustainability, transparency, ownership, human rights and social protection.
Thus, contrary to the widespread perception and reservations of developed countries, the UN has the expertise and balanced and representative deliberative body that could help advance from broad principles to a proposed mechanism or process. For example, UNCITRAL (United Nations Commission on International Trade Law) has a well-regarded existing expertise on international insolvency. Although its Working Group V on Insolvency Law deals with cross-border matters in mainly corporate bankruptcy and does not address sovereign insolvencies as such, it can easily address sovereign insolvency if the UNGA requests it to do so. In fact, after considering the broad principles to put into a framework for sovereign debt workouts during 2015, the UNGA could request UNCITRAL to develop proposals for operationalizing them after studying various proposals such as adoption of a model law that countries would adopt into their domestic legislation; an arbitration mechanism; a mediation service; something court like.
Challenges for the crucial next steps
The immediate next step is for the UNGA to decide on the modalities of the intergovernmental negotiations. It is important that member States that abstained or voted against to engage actively. There are reasons to believe that it would be the case. To begin with, for abstaining countries the door remains open in terms of their national decision to participate in negotiations and discussions, both in terms of process and substance. Second, there does not seem to be much disagreement among member States on the need for a new multilateral sovereign debt workout framework. Even countries with serious objections to the process believe that an orderly, timely and efficient sovereign debt workout mechanism is necessary. There is an overall unease with the ruling against Argentina in favour of “vulture hold-outs”. Even the US and France governments wrote amicus curiae briefs for Argentina, albeit at the appeals court stage. Some of the countries not voting in favour of the resolution have already legislated laws preventing vulture hold-outs from using their courts to obtain a favourable ruling. For example, Belgian has legislation to prevent misuse of Euroclear for this purpose. The British Parliament also legislated to limit what a vulture fund can get from a HIPC.[vi]
So, there seems to be an understanding about the significance of the issue. For the majority of the countries the reason for not voting in favour or abstaining has not been the idea itself, but not having enough preparatory time and discussion. As for the reservations regarding the suitability or expertise of the UN for such work, there are enough arguments to counter as listed in the preceding discussion. Therefore, it is important not to rush through which may appear a “tyranny of the majority” and to utilize the moment to build consensus at least on the modalities.
The most difficult would be, however, to agree on the substance or principles. It is increasingly recognized, especially among civil society organizations and development practitioners that the new legal framework must be placed within the context of universal human rights. That is, it not only makes binding and enforceable decisions, but that it also reduces the human suffering that debt crises cause, and also addresses the question of illegitimate debts. The view of the UN Special Rapporteur on Debt and Human Rights is that “international human rights law should be considered as applicable law in the context of debt restructurings”.[vii] However, the final outcome will depend on political power plays of different stakeholders and the continued solidarity of developing countries and vigilance of civil society organisations, such as EURODAD and Jubilee Debt Campaign.
Author's note: Views expressed herein are entirely personal and do not reflect the views of the United Nations or any of its entities, including UNESCAP.
1 Since 1990, a number of different ideas have been proposed. For example, Kunibert Raffer of the University of Vienna has proposed the internationalisation of Chapter 9 of the US bankruptcy code. Latin American economists, Alberto Acosta and Oscar Ugarteche have tabled the idea of a permanent ‘Sovereign Debt Arbitration Tribunal’ (TIADS) under the aegis of the United Nations. In 2001, the IMF’s Anne Kreuger put forward the idea of a ‘Sovereign Debt Restructuring Mechanism’ (SDRM) to be administered by the IMF. Most recently, Christoph Paulus and Steven Kargman outlined their proposals for a Sovereign Debt Tribunal which should be empowered to examine not just cases of unsustainable debt but also the legitimacy of individual creditor claims.
2 However, it was recognized that “in extreme circumstances, if it is not possible to reach agreement on a voluntary standstill, members may find it necessary, as a last resort, to impose one unilaterally.” The IMF Board further recognized that since “there could be a risk that this action would trigger capital outflows … a member would need to consider whether it might be necessary to resort to the introduction of more comprehensive exchange or capital controls.”
3 See Krueger, Anne (2002), ‘Sovereign Debt Restructuring and Dispute Resolution’ https://www.imf.org/external/np/speeches/2002/060602.htm
4 IMF (2013), ‘Sovereign Debt Restructuring—Recent Developments and Implications for the Fund’s Legal and Policy Framework’, http://www.imf.org/external/np/pp/eng/2013/042613.pdf
6 The Belgium legislation came after Elliot Associates collected on some Peruvian bank debt through Euroclear in Brussels, and the British Parliament acted after Donegal International collected in the UK courts on some defaulted Zambian export credits that Romania sold to them.
7 The Human Rights Council on 8 May 2014 appointed Juan Pablo Bohoslavsky as the Independent Expert on foreign debt and other related international financial obligations of States on the full enjoyment of all human rights, particularly economic, social and cultural rights. The mandate of the Independent Expert covers all countries and has most recently been renewed by Human Rights Council resolution 25/16.
Anis Chowdhury, former professor of Economics, University of Western Sydney, Australia. Currently, Director of Statistics Division of the Economic and Social Commission for Asia and the Pacific (UNESCAP).