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IFI governance

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Beyond HIPC – towards a fair and transparent debt workout mechanism

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11 October 2012

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Event Sponsors:, EURODAD, AFRODAD, EED, Jubilee USA, SLUG Norway, South Centre, 11.11.11 Belgium
This session facilitated an exchange of views among representatives from government, civil society, and the private sector regarding the implementation of reform proposals.

Panelists: Heikki Holmas (Minister of Development, Norway), Ludger Shuknecht (Department Head, Ministry of Finance Germany), Oygunn Brynnildsen (EURODAD), Yuefen Li (UNCTAD Debt and Development Branch), Martin Khor (South Centre)

Facilitator: Eric LeCompte

Eric LeCompte

This panel is part of an ongoing process that many of us have been involved in for more than a decade, examining how we find an end to the international debt crisis.

We are in a moment where we’ve seen a debt crisis spread from the global south and start to effect economies in the global north. We want to look at what are the real solutions to this debt crisis, in Biblical terms – how do we win a real Jubilee.

Our panelists have been invited to respond to a paper that was produced by the sponsoring organization, which has ten key points, argue for and discuss the enactment of a sovereign debt workout mechanism.

Oygunn Brynnildsen, Eurodad

It is clear that sovereign indebtedness has become a major challenge for global financial stability. A developing country problem has now turned into a threat to the global financial and economic system.

Europe is not the only continent where the situation is serious at the moment, according to the IMF a quarter of countries are at high-risk of debt distress. We also know that the situation is not likely to improve any time soon –debt/GDP ratios of LICs are projected to rise in about half of LICS

How do we deal with this? The answer is obvious – should we solve it or finance it? In recent decades, we know that every sovereign debt crisis has been treated as a liquidity crisis and not as an insolvency crisis. Financing packages have been used to continue debt service to external creditors – delayed debt cancellation has been more costly than earlier cancellation

Another consequence is the shift of exposure from private to public creditors. A procedure to resolve debt crises is needed prior to crises. In the middle of a crisis it is impossible to develop a mechanism. Once a mechanism is in place, both debtors and creditors will be better off.

One key reason that we would like to highlight is that the challenges are more complex, due to the range of creditors, instruments and the composition of debt itself. Now we have Southern states that themselves are lenders – new debts exists from new entities while there is greatly expanded multilateral post-crisis lending.

This underlines the need for a coherent and comprehensive debt workout mechanism. Without this, there are risks, such as that of free-riding and vulture fund activity. Ad hoc instruments are no substitute for a mechanism. Codes of conduct now exist, but a coherent framework is needed. Existing debt restructuring mechanisms tend not to discipline unscrupulous lenders. One example is DSA, which threatens to punish LIC borrowers with loss of access if they exceed borrowing limits set by the framework. An approach that unilaterally exerts pressure on borrowers, without disciplining creditors.

The aim of incentivizing sound lending and sound borrowing, a debt workout framework should change this. Today no binding and universal framework exists for sovereign debt restructuring, and debt workouts result in a messy process. Even in the absence of a universal legal basis, rules can still be agreed upon and implemented amongst the involved parties. The more rules-based and predictable a process, it will be speedier more efficient, effective and fair.

A broad range of proposals exist, since the 80s, such as standing debt courts, under the UN or permanent court of arbitration. Any existing mechanism would need to go beyond current mechanisms

      1. One single process needs to involve all creditors


      2. Impartiality over decisions over terms and conditions of restructuring


    3. Assessment over the validity of individual claims and debt sustainability.

These three basic principles are not new nor innovative. These reflect the rule of law in any orderly insolvency regime. Reform proposals have been made before. In 1998 UNCTAD demanded the creation of an international debt solvency framework. Recently some governments have committed to work toward a reformed framework.

Key is that indebted sovereigns demand a fair process, instead of creditor-dominated procedures such as the Paris club.
We’re here at the annual meetings of the IFIs, what should be their role? The failure of the SDRM initiative of the IMF demonstrates that they need to be part of a fair workout scheme only in their capacity as creditors, not as insolvency judges nor as advisors. Not a creditor and not a debtor is the UN system, free of any conflicts of interest. The UN system would be well placed to host a reform process and an eventual debt court.

Heikke Holmas, Norwegian Minister of Development

HPIC and the MDRI are still the cornerstones of Norwegian debt relief policy – and we will continue to ensure full financing for these schemes. HPIC is in a mature phase, at the same time many post-HPIC states face the risk of new debt distress. We need something more than today’s HPIC. More should be done to discuss debt increases and other issues creating debt burdens.

We believe debt cancellation should be conducted based on how they were given, not just on how much can be handled; debt cancellation is not just about sustainability but responsibility. Asymmetric power exists between debtors and creditors. We have to be pragmatic; the discussion of improvements must not be droned out by efforts to make the overall structure better.

Ludger Shuknecht Department Head, Ministry of Finance for Germany,

We have learned recently painfully that even industrialized countries are not immune to this. In principle I can agree that debt workout mechanisms need to be improved. However, I do not think that there are silver bullets – it is more an issue of trial and error, and moving forward in steps while trying not to keep the economic perspective out of focus.

I would not underplay the role of the Paris club and the London club, which have weaknesses, but in many cases provide the solution. I share the view that collective action clauses are very important, not as a substitute, but they help to speed up resolution processes which has been agreed in eurozone countries.

This is important, realistic and concrete to set preconditions to deal with possible debt overhangs. At this stage, I am sceptical to go beyond that, as a legally binding structure such as a debt court. Firstly there are budgetary considerations, political agreement would be hard to find. More fundamentally, the question that this proposal raises is a balance between debtors and creditors in the contractual arrangement that they have entered into. There is an issue of contract fulfillment that is an inbuilt bias. The issue of balance is very important.

A shift in the balance may help existing debtors, but may make life harder for future debtors as risk premia may rise, they may not get any credit at all. This major shift in the balance may backfire quite badly and leave countries exposed to the loan sharks that one would not want to leave them with. There is also the question of validation, of course over-indebtedness accumulated by a dictator is to be treated differently to debt from adverse events. Thus the issue of balance is important, thus this proposal may shift it too much, to the ultimate detriment of poor countries.

Argentine minister of finance and vice minister of economy

I would like to start my speech by mentioning what we consider key elements when we talk about sovereign debt restructuring.

Issues that do not allow a country to complete a chapter, even when it is able to get a result in terms of level of acceptance. That is the case of Argentina, where 92% acceptance after 10 years, indicators validate the debt restructuring process itself, but also what we consider even more important is a permanent debt restructuring process which gives the country the opportunity to restructure internally. Even in that situation we have to continue to face the consequences of what we consider a crucial issue in the international legal framework.

Basically a sovereign debt crisis is always a consequence of unsustainable macro economic conditions. How to achieve a consistent sustainable path consistent with the payments required, or it will not be sustainable.

Unfortunately this approach is not always present in the discussion between creditors and sovereign debtors. In our experience a key issue was to define the correct timing, and other key priorities of the restructuring process. After that we began to focus on the micro-economic conditionalities, and all the other elements surrounding a debt restructuring process.

Another important issue is the debt composition. If we talk about the composition, we talk about the necessity of a very careful liability management strategy, when you define the issue you are negotiating. It is very important to know who are the holders of your debt.

Where are the problems? Even after 10 years of working very hard in what we consider an important component of our macroeconomic agenda, we still find that if there is no solution of the sovereign debt restructuring mechanisms, this kind of process can never be concluded. A 92% level of acceptance should be more than enough, in terms of having the legal basis given that the legal holdouts, we are referring basically to vulture funds.

A crisis resolution mechanism should involve an impartial independent evaluation, an independent evaluation of the debtor’s situation, an impartial process of channeling creditors’ claims. Another important issue that a crisis resolution mechanism should include, is the right of the debtor country to make a proposal to take into account all parties. If not the process will not be politically, socially or economically sustainable. Key elements from our experience requires consistency of objectives, priority, and sequencing. Financial policy must be totally integrated not only with restructuring but also the rest of policy, including social policy goals.

If we don’t talk about inclusive growth process it seems difficult to discuss the next thirty years, and that’s why we must discuss the consistency of the macroeconomic situation. Closing the existing gap in the international legal framework remains a central task and Argentina will continue to support all initiatives to advance these discussions.

Yeuefen Li, head of UNCTAD debt and development branch.

This will be a long haul struggle. There are different views, be it statutory or close to statutory mechanism. Such a mechanism is not a panacea, but without it there is no predictability and sometimes its absence increases the pain and cost of the debt resolution process.

In October the gen assembly will have a special event on the debt workout mechanism and the debt crisis. This is the first time it deals with the issue independently, in particular as an in session event. Member states believe it is necessary to discuss this issue. Another step forward, is the UCNTAD principals on responsible sovereign lending and borrowing. The support of 13 countries is a breakthrough – having said this there remain a lot of obstacles in achieving the goal of a debt mechanism.

If you look at the recent published IMF survey about the debt restructurings, you can see why. For instance, a mechanism for getting out of debt crisis, the most important elements are two: there must be debt relief, and there must be growth. Debtors can only grow out of crisis through growth, and the current system of Collective Action Clauses (CACs) does not permit. They only apply to bonds, and not all bonds have them. They do not guarantee priority, meaning that debt dilution.

Thirdly there is no interim financing, which is crucial for growth. Fourthly CACs and debt exchanges do not solve the problem of the debt burden. The latest IMF findings show that few cases had CACs, and found that their presence alone does not enable resolution, and also that they cover holdouts, but holdouts do not represent the bulk of debts.

Mariana Williams, AFRODAD

This very rich panel was very good, despite tensions and reservations. I heard that everyone recognizes that there is a problem with a system that does not deal in a very fair transparent or systematic way with debtors and borrowers.

Hence I heard that the current system does allow debt workout to occur, but it is messy and rogue creditors drag out the process and therefore it impinges and imposes cost. Financial cost and human costs, we know from history that decades of lost generations due to a  reluctance and resistance to admitting there was a solvency problem, which menat ths solutions were too little too late.

This system cannot deal with severely indebted middle income countries – we need a system that can take into account all of these, including the new instruments that are not traditional syndicated loasn including post crisis debt and export credit and so on, plus it is overly biased, due to political bias and creditor domination.

Conceptually we know what we need to remedy the missing part of international financial architecture – Ann Kreuger said despite having resisted such mechanisms for decades, said we need an independent and neutral system that includes equal treatment of all.
A binding and universal framework – though the panel disagrees whether it would deal with problems in their totality – I think many questions and answers actually challenge some of those. There is some disagreement as to whether one single insolvency mechanisms. I don’t know that any one disagrees that impartial system is required.

Why do we need such a system? Countries need a fresh start – they need fiscal space, not consolidation – there are a group of countries at this table, and NCTAD is one of them making proposal since 1988 at least and have now created this principal in lending and as we move forward the government of Norway has validated UNCTAD’s work and we hope that more seminars with like-minded countries.

We need to demystify a lot of the concepts and myths and ideas emerge so  we need to have discussions which identify so that we know of the history of debt forgiveness, including the history of debt crises – thus it is time to put in place a new mechanism that is universal. And an approach that actually takes care of borrowers and lenders, and we ask Germany as part of the EU and G20 and that it consult with the Russian president, to discuss these issues at the G20 level which links up the other inspiring and progressive aspect, is that the UN Gen Assembly is now having as part of its intercession an event to learn from the lessons of the debt crisis.

Thus we can eventually have a more sane and realistic and humane approach to dealing with restructuring that is development friendly and human rights friendly.

Of course we know that the parliament of Switzerland has asked the minister of finance to respond to the need for a debt workout mechanism which will be forthcoming at the end of the year. Thus there are processes to examine the debt workout mechanisms, and though this is in process.