Presentation of my new paper: 'An International Insolvency Law for Sovereign Debt?' Seminar on “Sovereign Debt Restructuring and the Rights of Private Creditors”. July 14, 2014, House of Finance - Frankfurt.

1. An International Law for Sovereign Debt?
Learnings from the Euro Crisis
Luca Amorello
Seminar on
“Sovereign Debt Restructuring and the Rights of Private Creditors”
July 14, 2014, House of Finance - Frankfurt.

2. In a nutshell:
A. Early Stages of Sovereign Restructuring
B. The Euro zone experience:
a) The debt challenge of the Euro Area
b) The Greek Financial Crisis
C. Criticalities of Greek market-based restructuring approach:
a) Effectiveness and Timing
b) Collective Actions problems
c) Interim Financing
D. Alternative approaches?
a) The Statutory-based model
b) Major Proposals
c) Criticism
E. The Common Core of International Insolvency Law:
a) Flexibility
b) Single Forum and Comprehensiveness
c) Non discrimination and Independency
d) Participation, Transparency and Good Faith

3. A. Early Stages of Sovereign Restructuring
 No single Resolution mechanism currently exists to deal with Sovereign
Insolvency;
 Different approaches have been put forward over time and are currently
available:
 Contractual Approach
 Statutory Approach
 No general agreement on which Sovereign Debt Restructuring mechanism
is preferable.
 However, after the financial crisis of 2008, we may recognize a common
core of principles that should be used to design a global International
Insolvency Law.

4.  Since XVIII Century almost all States had to disentangle the criticalities
associated to Sovereign Insolvency.
 Sovereign Insolvency occurs when a country is perceived to be unwilling or
unable to repay its debt over the long run.
 Feature of such Insolvencies is that States have always operated without a
comprehensive Insolvency framework.
 In the past private creditors and official creditors used to organize informal
negotiations and ad-hoc fora to deal with debtor countries:
 Paris Club
 London Club

5.  Since 80’, the IMF has acted as lender of last resort to defaulting States,
replacing informal fora.
 The IMF provided financial assistance promptly and its conditionality was
expected to strengthen debtor’s commitment to adjust its internal policies.
 The IMF also acted as information provider amongst creditors, thereby
reducing uncertainties and information asymmetries.
 However, the IMF as lender of last resort resulted inadequate:
 Absence of a minimum set of widely accepted rules for restructuring;
 No enforcement instruments able to monitor borrowers’ behavior;
 Restricted resources at its disposal;
 Cost of Moral Hazard.

6. B) The Euro zone Experience
 During 2008 and 2009 the Euro Area debt market was relatively calm;
 However, in late 2009 a number of countries experienced dramatic increase
of Deficit/GDP ratios.
 The European Sovereign Debt crisis erupted firstly in Greece with risk of
financial contagion;
 Finance ministers of Euro zone created the European Financial Stability
Facility (EFSF) in May 2010 as permanent rescue mechanism for defaulting
EU States.
 However, the Euro area crisis have shown that the monetary and fiscal
policy framework of the EMU is still incomplete.

7. The Greek financial crisis
 Three main steps of Greek rescue:
 On April 2010, first rescue package of around €80 billion in EU loans and
€30 billion in IMF credit with conditionality.
 On July 2011, the EU governments agreed to support a new program for
Greece of €109 billion. In particular, this program provided a voluntary debt
exchange and a buyback plan developed by the Greek government. Yet, due
to increasing recession and difficulties to achieve an agreement amongst
parties, this plan was never implemented.
 On February 2012, finally parties agreed on a major take-it-or-leave-it debt
exchange offer aimed at reducing Greek’s debt ratio.

8.  By the take-it-or-leave-it exchange offer, the participating investors would have
received a bundle for every old bond consisting in:
 One or two EFSF notes in two separate series with different maturity for a face
value of 15% of the old bond;
 A bundle of 20 new English-law bonds with a maturity of up to 30 years maturing
between 2023 and 2042 amounting to 31.5% of the old debt’s face value;
 A set of detachable GDP-linked securities which could offer a modest increase in
the coupon on he new principal of up to 1% if GDP exceeded a specific target path;
 Compensation for any accrued interest in the form of ESFS notes.
 The public offer was lunched on 24 February and on 9 March, the Hellenic
Republic announced that bondholders holding 85,5% of old bond agreed to the
bond swap. By the end of the exchange the participation rate rose to 95.7%.
 The nominal face value of Greek debt was reduced by 53.5%, which
corresponded to a reduction in the Greek debt stock of €107 billion.

9. C. Criticalities of Greek market-based restructuring approach
 The Greek debt restructuring approach has been essentially market-based.
 The exchange offer has been used to stretch out the maturity date of each
bond and lower the face value of debt held by private investors.
 However, such mechanism – albeit useful – cannot be considered fully
satisfactorily. In particular, some criticalities should be noted:
a) Effectiveness and Timing;
b) Collective Action Problems;
c) Interim Financing.

10. a) Effectiveness and Timing
 In a restructuring procedure for Sovereigns the chances of reaching an
agreement between debtor State and creditors are low given the conflicting
interests of the parties involved.
 In the Greek case, despite the stock of privately held public debt at the end
of 2009 amounted to €253 billion, the first package was delayed until May
2010.
 Moreover, although it was clear in July 2010 that Greece would not be able
to make the necessary fiscal adjustment and reforms, EU members and
private creditors wasted further nine months in negotiations to set a new
credible restructuring package.
 Even if we assume the efficiency of such approach, the lack of a single
timeframe and the absence of coordination amongst parties resulted in the
exacerbation of the debt burden.

11. b) Collective Action Problems
 Collective action problems are:
 Difficulty to reach an undisputed consensus amongst creditors on the
restructuring terms;
 The so-called “grab race”: creditors, fearing that other creditors will be the first to
enforce their claims against assets that are insufficient to pay all claims, may be
incentivized to anticipate others by going to court and asking for relief.
 The so-called “hold out problem”: a single creditor may decide to hold out, hoping
that the overall desire to reach an agreement will induce the debtor or other
parties to buy on their claim or pay them a premium.

12.  The contractual approach in Sovereign debt restructuring attempts to address
such problems through the integration of collective action clauses (CACs) into
bond contracts;
 CACs enable bondholders to approve a restructuring in a vote that binds even
dissenting bondholders. More precisely, they bind creditors to the provisions laid
down in the bond contracts forcing a possible holding-out minority to accept the
debt restructuring;
 Different majority thresholds around the globe (unanimous/supermajority);
 Market practice today shows a good, despite not global, acceptance of the
CACs in International Sovereign bonds.
 In Euro zone, Euro Members amended in February 2012 the ESM Treaty
providing the mandatory inclusion of standardized CACs in all new EU
member’ bond.

13.  CACs are efficient or inefficient? Three main problems:
a) The efficiency of CACs is linked to the amount of bonds issued. If there are few
simple bonds profiles to deal with, creditors may reach an agreement relatively
easy. Otherwise, CACs may result insufficient to provide a satisfactorily
comprehensive restructuring strategy.
b) The contractual approach cannot bind previous creditors whose bonds lack
CACs for changing essential terms, unless they agree ex post to include them in
their bond indentures.
c) The presence of holdouts can deter other creditors to agree on a reasonable
restructuring plan.
 A possible solution to these criticalities might be for a Sovereign debtor to
engage in exchange offers by offering its creditors the option of exchanging
their debt claims for a new debt security containing CACs.

14.  This strategy, however, may be very costly!
 To induce bondholders to accept the exchange, a Sovereign might be obliged to
offer cash payments or premiums;
 It might be required that accepting creditors waive any covenant protections in
their financing agreements that could be waived without unanimous creditor
consent;
 Chancing unilaterally fundamental terms of the contract, could represent for
holdouts unenforceable coercion;
 If the new claims are perceived to have equal priority to the old ones, the
exchange offer might fail because old creditors have no incentive to tender their
bonds.

15.  What about the Greek experience?
 Many of these problems have been overcome in the voluntary exchange by
changing local law to effectively incorporate a CAC in all untendered local-law
bonds (“Greek Bondholders Act”);
 However those retrofit CACs are not sufficient to solve all the problems underlined
above:
a) Some Constitutions protect bondholders by guaranteeing the payments of
government’s debts while others provide that government debt payments take
priority over other obligations of the State;
b) Coercitive expropriatory power of laws like the Greek Bondholders Act;
c) CACs are never incorporated in Sovereign guarantee: then, holdouts might
insist on payment by the guarantor of the amount originally due under the bond;
d) Some categories of Greek debts have been excluded from the exchange (i.e.
ECB’s stock). These bonds enjoyed a de facto seniority that not only may be
seen by other creditors as a discrimination in the distribution line but also
contributed to Greece continuing debt burden.

16. c) Interim Financing
 During the debt restructuring process a defaulting State needs to obtain funding
to pay ongoing expanses;
 However, the contractual approach is inadequate to address the need of new
funding during the restructuring:
 Even if Institutions like the IMF, or the ESM, provides financing, this new liquidity is
not legally tied to the voluntary exchange offer.
 Thus, three possible externalities:
a) There will be incentives for creditors to delay the restructuring negotiations in the
hope of further external intervention;
b) In the short period the country will still need to borrow from banks or capital markets
but this will result impractical, if not impossible;
c) In the long run there will be a continuing need of a governmental lender of last resort
along with the associated moral hazard effect.

17.  What happened in Greece?
 The restructuring of Greek Sovereign debt required massive official financing.
 Yet, on one side, the Greek case shows that a defaulting State is factually
excluded from capital markets following its default until the conclusion of the
restructuring procedure. Thus, in the short term becomes difficult to raise capital
from privates, if not impossible.
 On the other side, official liquidity for rescue package is becoming increasingly
difficult to rise in the Euro area both because of public and political opposition to
further bailouts and because the pool of available resources is shrinking, as
demand continues to increase.

18. Alternative Approaches?
 The Statutory-based model: this approach implies the establishment of an
international body or mechanism, developed under a universal Treaty, which
would supervise the entire Sovereign restructuring.
 The Treaty thus would impose a legal framework binding all the creditors,
including holdouts in agreeing with a Sovereign debtor on a restructuring of its
outstanding debt.
 Major restructuring problems associated to the contractual approach, can be
solved through the implementation of such International Insolvency Treaty.

19.  In particular:
 Through the Treaty creditors can be ensured that debtor State will negotiate in good
faith and will pursue policies that help protect the value of creditors’ claims;
 The collective action problems for debtors would be solved by supermajority voting
that binds all parties to the agreement as well as the bankruptcy law solves the
problem for debtor-corporation;
 Imposing a stay or temporary moratorium on creditor litigation and enforcement
might accelerate the economic recovery of debtor by permitting the State to suspend
payments while attempting to restructure its economy;
 The Treaty could provide seniority and protection from restructuring to fresh private
lending;
 The Treaty would prevent the politicization of negotiations.

20. Relevant proposals
 Sovereign Debt Restructuring Mechanism (SDRM):
 Proposed by the IMF in 2001.
 The Idea was largely focused on the setting-up of a Sovereign Debt Dispute
Resolution Forum, with limited but exclusive powers for the orderly conduct of any
debt settlement under the SDRM. Four keys principles would have guided this
Forum: independence, competence, diversity and impartiality.
 Despite almost two years of debate, the SDRM was struck down in 2003 because
of the lack of support from US and some major developing countries.
 European Crisis Resolution Mechanism (ECRM):
 Proposed by leading Professors in 2010.
 It would have been established by a Treaty and based on two pillars: I) A
procedure to initiate and conduct negotiations between a Sovereign and its
creditors leading to an agreement on how to reduce the present value of the debt’s
obligations; II) Rules for the provisions of financial assistance to euro-area
countries as part of resolving the crisis.

21. D. The Common Core of an International Insolvency Law
 The European experience helps us to recognize a common core of
principles that policymakers must take into account in future to develop an
International Sovereign Insolvency Framework.
 We think that the efficiency of a Global restructuring Law for Sovereign Debt
will mostly depend on the implementation of such principles:
a) Flexibility;
b) Single Forum and Comprehensiveness;
c) Non-discrimination and Independency;
d) Participation, Transparency and Good Faith.

22. a) Flexibility
 Need to tailor specific treatments for defaulting countries in view of their
political and socio-economic challenges while maintaining the general rules
and criteria intact;
 Many of the Sovereign debt restructuring proposals have been wiped out
because they ignored the political realities involved when a country faces a
financial crisis;
 This principle must be rationale for a case-by-case crisis management
approach:
 This would imply, for example, a greater use of unorthodox policies such as short
term capital controls, differentiation in the treatment of debtors based on political
and social circumstances and easier access to interim financing for prime
borrowers.

23. b) Single Forum and Comprehensiveness
 Restructuring procedures tend to fragment into multiple fora.
 The Greek restructuring showed that the inclusion of CACs in Sovereign
bond contracts can strengthen inter-creditor coordination, but cannot bring
together stakeholders to assess a Sovereign’s insolvency and to craft viable
responses at an early stage.
 Therefore, there must be a dedicated forum where every claimer must
participate.
 This complements the need of a comprehensive treatment of all claims in a
single process that would make easier and more effective the relief.
 Standardization of bond contracts and related guarantees with the
introduction of CACs, as achieved in the Euro zone recently.

24. c) Non discrimination and Independency
 In the Greek case the ECB enjoyed a de facto seniority on its debt stock,
due to their exclusion from the deep haircuts imposed on private creditors
during the exchange offer;
 The resulting subordination of private claims constituted discrimination
against private creditors, thereby causing amongst investors an adverse
effect on the perceived credit risk of Sovereign debt in the Euro area.
 Threat of higher premiums to be paid to private investors because of their
de facto subordination.
 Institutional mechanisms to avoid such discrimination are still missing.
 Thus, need to consolidate the principle of non-discrimination in future
restructurings.

25.  The Sovereign restructuring procedure must be independent of any creditor
institutions.
 During the Greek crisis, the IMF and some highly involved EU members had
a monopoly on decision-making process due to their credit exposure. This
led eventually to a conflict of interests.
 Such conflict of interests may entail skewed analysis, insufficient debt relief
and unfair burden-sharing among creditors for a given level of debt relief.
 Need to establish an independent and neutral body which provides all the
assessments and decisions needed for the restructuring workout over which
neither creditors nor debtor may exert any influence.

26. d) Participation, Transparency and Good Faith
 A general right to participate in the proceedings has to be granted to debtor,
in order to reduce the “domestic costs” of the restructuring;
 The Greek case showed how the risk of insolvency may put great pressure
on government officials.
 Such political cost may be reduced if the civil society representatives of
debtor countries were formally granted rights of being heard and making
proposals, thereby guaranteeing a more democratic involvement in the
restructuring workout.
 The efficiency of the restructuring procedure must not be separated any
longer from the legitimacy issues arising from the implementation of the
restructuring mechanisms.

27.  The Greek case finally showed that the collaboration of private creditors in
the restructuring procedure is essential.
 Therefore during the negotiations private creditors must have the
opportunity to discuss the overall macroeconomic response to the crisis and
be timely informed of the changing circumstances.
 This consideration stresses the importance of transparency and good faith
as general principle of law for the facilitation of Sovereign debt negotiations.
 Need to formally recognize such principles in the international practice
through the amendment of the existing Treaties or though the development
of a comprehensive Statutory approach.

28. Thanks for participating