[stop-imf] Krueger: Sovereign Debt Restructuring and Dispute Resolution

[Robert Weissman]

Sovereign Debt Restructuring and Dispute Resolution
Anne Krueger
First Deputy Managing Director
International Monetary Fund
Bretton Woods Committee Annual Meeting
Washington DC, June 6, 2002

1. Introduction

Mr Chairman. Ladies and Gentlemen.

It is a great pleasure to be here today, to be speaking alongside my
colleague John Taylor and in the presence of this distinguished
audience. The Bretton Woods Committee has long played a vital role,
supporting the principle of international cooperation in the global
monetary and financial arenas, and helping to ensure that there is
informed debate here in the US on the key policy issues of the day.

What I would like to do today is to bring you briefly up to speed with
progress on the two-track approach to improving sovereign debt
restructuring that was endorsed by the US and the rest of the
international community at our recent spring meetings.

The first track involves more ambitious use of collective action clauses
in sovereign bond contracts. The second ? and complementary ? track
involves creating a statutory mechanism that we believe that can 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.

A key challenge that confronts both approaches is the coordination of a
diffuse and diverse creditor base, with different creditors able to seek
enforcement of their rights in different legal jurisdictions. Dealing
with this issue when relying entirely on collective action clauses is
very difficult. But within the statutory approach, we believe that it is
possible to resolve this coordination problem through the creation of a
framework that would aggregate claims across instruments for voting
purposes, while paying due regard to the seniority of certain creditors
and, more generally, to creditors' varying economic interests.

A framework that provides for such aggregation would require the
establishment of a dispute resolution forum that would enjoy limited but
exclusive powers for the orderly conduct of the restructuring process,
including the resolution of disputes between a sovereign debtor and its
creditors, on the one hand, and amongst creditors, on the other hand.
Some commentators have expressed fears that the creation of such a forum
might be a back-door way for the Fund to exert a malign influence over
the restructuring process. That is not the case, so I will focus in my
remarks today on how such a forum might be set up and operate.

But let me first begin with a general introduction to progress so far.

2. The Two-Track Approach

Our discussions to date reveal widespread agreement on our basic
diagnosis: that we lack adequate incentives for orderly and timely
restructuring of unsustainable sovereign debts. This can impose
unnecessarily heavy economic costs on debtor countries; it can undermine
the value of creditor claims; and it can leave the international
community confronting an unpalatable choice between a disruptive
unilateral default or bailing out private creditors and contributing to
moral hazard.

The problem in large part reflects the way that international capital
markets have evolved over the last two decades or so. Capital markets
have become more integrated and there has been a shift from syndicated
bank loans to bond issues. As a result, sovereign borrowers increasingly
issue debt in a range of legal jurisdictions, using a variety of
instruments, to a diverse and diffuse group of creditors.

This has widened the sources of finance available to emerging market
countries. But at the cost of increased problems of coordination,
collective action, and inter-creditor equity when debts have to be
restructured. In consequence, necessary restructuring has become much
more difficult and less predictable than it was in the 1980s. Our goal
is not to make default an easy way out., but rather to create better
incentives for timely and orderly restructuring while protecting asset
values and creditors' rights.

The key to improving the current system is to allow a super-majority of
creditors ? across a broad range of instruments ? to make the terms of a
restructuring binding on the rest. This should help secure restructuring
prior to default. But, in case this proves impossible, the new approach
would also need to do the following:

   * First, to give the debtor legal protection from creditors while
     negotiating;

   * Second, to give the creditor assurances that the debtor will
     negotiate in good faith and pursue policies that protect asset
     values and restore growth, and;

   * Third, to guarantee that fresh private lending would not be
     restructured.

Finally, you also need a way to verify claims, oversee voting, and
adjudicate disputes.

These are familiar features from domestic bankruptcy regimes. The
parallel should come as no surprise. As Adam Smith wrote in 1776: "When
it becomes necessary for a state to declare itself bankrupt, in the same
manner as when it becomes necessary for an individual to do so, a fair,
open and avowed bankruptcy is always the measure which is both least
dishonorable to the debtor, and least hurtful to the creditor."

Use of the mechanism would be for the debtor to request, and not for the
Fund or anyone else to impose. As I mentioned earlier, in common with
domestic bankruptcy regimes, the existence of a predictable framework
should in most cases be sufficient to encourage voluntary agreement "in
the shadow of the law", without formal activation.

Collective action clauses ? typical of bonds issued under English law ?
are one way to provide the key features of the new approach. This is our
first track. But they have important drawbacks. To begin with, they only
bind holders of a single bond issue. If CACs are to facilitate
comprehensive restructuring ? which is what would be required ? then
they need to be adapted to aggregate across all claims, including banks.

But such "super collective action clauses" are problematic for three
reasons:

   * First, how do you persuade creditors and debtors to issue new debt
     and exchange existing debt for bonds that include these clauses,
     when they are already reluctant to include ordinary CACs? One
     suggestion has been to make this a condition of access to Fund
     lending. But this would be the time at which the private sector is
     most reluctant to lend and when the debtor may be most reluctant to
     signal a greater chance of default by adopting them.

   * A second problem is that emerging market sovereigns typically
     borrow in several legal jurisdictions. Not even identical
     restructuring language in CACs would necessarily guarantee uniform
     interpretation or application.

   * Third, the current domestic laws of some of our members do not
     provide a clear statutory basis that allows the rights of minority
     creditors to be modified without their consent.

We are working on ways to tackle these drawbacks, but in the end I am
sure that we will need a statutory underpinning for the new approach as
well. Hence the second track.

The statutory approach would use a treaty obligation ? probably achieved
through an Amendment of the IMF's Articles of Agreement ? to empower a
super-majority of creditors to reach agreement with the debtor and bind
in the rest. This would resolve the problem posed by different legal
jurisdictions, as the treaty obligation would provide for legal
uniformity in all jurisdictions. Moreover, the establishment of a single
and exclusive dispute resolution forum would ensure uniform
interpretation.

But I should emphasize that an amendment of the articles would be used
only as a tool to empower the creditors and debtor, not as a way to
extend the IMF's legal authority. The Fund would only influence the
process as it does now, through its normal lending decisions.

As we continue to develop this two track approach, we are working on a
number of questions. For example:

   * How should the member's initial request for a stay be dealt with,
     given the time it would take for creditors to be in a position to
     vote?

   * How should Paris Club debt be treated in the restructuring process?
   * How should we treat sovereign debt owed to domestic creditors?

   * How can we promote a collaborative interaction between debtors and
     creditors, rather than the use of take-it-or-leave-it exchange
     offers?

   * Should we extend legal protection to viable firms prevented from
     servicing their debts by the imposition of exchange controls?

And then there is the question of how best to secure the verification of
claims and adjudication of disputes. It is this I will focus on in the
rest of my remarks.

3. Dispute Resolution under a Sovereign Debt Restructuring Mechanism

For the new approach to sovereign debt restructuring to enjoy
credibility and legitimacy, it will need to have the capacity to resolve
disputes among creditors ? and between creditors and the debtor ? in a
way that is demonstrably fair to all parties.

This role could not therefore be played by the Executive Board of the
IMF. Not only do Executive Directors lack the necessary expertise, but
their decisions could be thought to be influenced by the Fund's role as
a creditor and by the representation of the debtor and bilateral
creditors on the Board. Indeed, the dispute resolution forum should
operate ? and been seen to operate ? independently not only of the
Executive Board, but also of the governors, management and staff of the
IMF. The flipside of this independence is that the role of the dispute
resolution forum should be strictly limited.

Our thinking on the dispute resolution forum is far from complete, but
let me describe briefly what shape we think it could take. I will deal
in turn with three aspects: the powers of the forum; its composition,
and; the legal status of its decisions.

Powers

The first set of powers that the forum would need to exercise would be
the administration of creditor claims. This is a purely administrative
function, similar to what a domestic bankruptcy court would do. This
would involve notifying creditors that the debtor had requested
activation of the mechanism; identifying the claims submitted by
creditors; and publicizing dates, places and procedures for voting.

The forum would also administer the voting process, organizing the
meetings at which it took place and the recording of votes cast. More
ambitiously, the forum ? or, indeed, a separate private institution ?
could also be given responsibility for administering a permanent
sovereign claims registry. Registration would be voluntary, but
participation could well come to be seen as part and parcel of prudent
debt management. It would certainly make creditor coordination much
easier in the event of a crisis.

The second set of powers would be the resolution of disputes among the
creditors, or between creditors and the debtor. Disputes would likely
arise in two main areas:

   * First, verification of claims. Creditors may be concerned about the
     creation of fictitious claims that could be used to manipulate the
     voting process. There may also be disputes regarding the value of
     claims and the collateral that secures them.

   * Second, integrity of the voting process. If claims are to be
     aggregated across instruments for voting purposes, ensuring
     integrity of the voting will be of critical importance. Even if all
     the claims are bona fide, there might still be a perceived risk of
     collusion between the debtor and certain creditors in the voting
     process. For example, some creditors could be offered undisclosed
     financial incentives to vote in a particular way. Creditors may
     also be concerned that the sovereign might try more subtle forms of
     influence, for example using its regulatory powers to put pressure
     on domestic creditors subject to government regulation or control.
     The statute setting up the mechanism would need to include rules to
     safeguard against these abuses. The dispute resolution forum would
     be charged to adjudicate their interpretation and application.

This would be the limit of the forum's powers. It would have no
authority to challenge decisions by the Executive Board of the Fund, for
example regarding the adequacy of the members' policies or the
sustainability of the member's debt. Just as importantly, it would have
no authority to override the decisions of a qualified majority of
creditors on such issues as the terms of a restructuring plan or the
length of a stay. Its role would be essentially reactive. For example,
although the forum could resolve disputes regarding the application of
creditor classification rules, it would not itself be responsible for
classifying creditors in the first place.

Composition

Now let me turn to the possible composition of the dispute resolution
forum. In order to command the credibility and legitimacy necessary to
carry out its functions effectively, the setting-up and operation of the
dispute resolution forum would have to be guided by four basic
principles: independence, competence, diversity and impartiality. These
principles could be achieved through a five step process:

   * Step One: Each of the IMF's 183 members would have the right to
     nominate one candidate, who need not be a national of the
     nominating country. Such a large pool would guarantee diversity of
     geography, legal tradition and professional experience, as well as
     making it possible to ensure the inclusion of members from both
     debtor and creditor countries. Soliciting nominations from members
     directly rather than from the Executive Board would also help
     ensure independence from the Fund.

   * Step Two: An independent and qualified committee of eminent persons
     could be established by the Executive Board to vet the nominees and
     recommend a list of, perhaps, 21 for selection to the forum. The
     committee could be guided by the advice of independent,
     international professional associations that are expert in
     insolvency and debt restructuring, for example the International
     Federation of Insolvency Professionals, the International Bar
     Association's Committee J, and the International Insolvency
     Institute. It could also consult with representative associations
     of private creditors . The private creditors we have spoken to say
     that they would prefer the members of the dispute resolution forum
     to be practicing judges experienced in debt restructuring, but
     membership could also be open to retired judges, academics or
     practitioners.

   * Step Three: The names recommended by the committee could then be
     passed to the Board of Governors for approval. They would have to
     vote on the entire list as a package. If it was rejected the
     process would have to start again. Following approval by the
     Governors, the Managing Director could then appoint each member of
     the forum for a renewable term of four or five years.

   * Step Four: The appointed members of the dispute resolution forum
     would then elect a Presiding Member from among their own number,
     with specified duties to oversee the functions and operation of the
     forum. It is important to emphasize that none of the members would
     be full-time employees of the forum. They would continue to work as
     normal in their own countries unless they were impaneled for a
     particular case.

   * In the fifth and final step, when an actual case was submitted to
     the forum, three members would be impaneled by the Presiding
     Member. The Presiding Member would take good care to ensure that
     members with conflicts of interest in specific cases were not
     permitted to serve on them. The Presiding Member could also set up
     a committee to draft the procedural rules of the forum, which would
     then have to be approved by the forum as a whole.

We believe that a process of this sort would provide the guarantees of
independence, expertise, diversity and impartiality that the dispute
resolution forum would require to secure the necessary credibility and
legitimacy. There are of course other questions of powers and
composition that would have to be dealt with.

Legal Status of Certain Decisions

In addition to resolving disputes, the dispute resolution forum would
certify key decisions made by the debtor and a super-majority of
creditors, including with respect to the final restructuring terms and
the stay. These certifications of the dispute resolution forum would
need a legal status making them binding on all member countries. In
other words, they would need to be treated as though they were decisions
of each member country's national courts. This means that each member of
the Fund would need to comply with the forum's certifications and give
effect to them in its territory ? whether or not the member was a party
to the particular case in question. The debtor or creditors would notify
particular domestic courts or other authorities of a certification as
and when it became necessary for them to enforce their rights.



It should be emphasized, however, that certifications would be based
exclusively on the decisions made by a qualified majority of creditors.
The dispute resolution forum would, in effect, only be certifying that
the vote of the creditors had taken place in accordance with the
procedural requirements and that there had been no evidence of fraud.
The certification would not be based on the exercise of a dispute
resolution panel's discretion.

3. Conclusion

To conclude, let me say that I understand that all countries ? and,
perhaps, this one in particular ? are reluctant to cede or share their
sovereignty over decisions that are important to their citizens to
international forums. But if we have learnt one thing from the turmoil
that many emerging market economies have been through in recent years,
it is that the health and stability of the global financial system
cannot be secured by a single nation working alone. International
cooperation is essential to ensure that the system works as smoothly as
it can, otherwise we all bear the costs.

In a world in which sovereign borrowers have diffuse and diverse
creditor bases, we need a way to overcome the coordination and
collective action problems that stand in the way of timely and efficient
restructuring. For both the contractual and statutory approaches, that
means addressing the problems created by the diversity of legal
jurisdictions in which creditors can seek repayment. We believe that a
dispute resolution forum ? small in size, limited in role, and
demonstrably independent in its membership and operation ? is the best
way to achieve this. To help avoid chaotic defaults or expensive
bailouts in the future, that is surely a price worth paying.

Thank you.

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