Lessons learned on debt restructuring in Latin America and the Caribbean. Carlos Steneri October 10, 2013 Wash. DC

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1 Lessons learned on debt restructuring in Latin America and the Caribbean Carlos Steneri October 10, 2013 Wash. DC

2 Recent economic events have instigated the renaissance of an important sequence of sovereign debt restructuring in LAC Belize (2007,2013), Jamaica (2010, 2013), St Kitts and Nevis (2012) and. Grenada is currently in the middle of a similar process. The region presents early and successful examples in debt restructuring (Uruguay 2003, Dominican Republic 2005).

3 Some Lessons on Debt Restructuring Uruguay (2003), and the Dominican Republic (2005) debt exchanges were implemented through a market based scheme (Contractual Approach), which includes Collective Action Clauses (CAC s). The main results were: The achievement of the necessary debt relief The access to the capital markets promptly The lack of hold outs problems or legal litigations

4 In other cases debt restructuring, using the same approach, has been too little and too late, because: Debt alleviation post exchange was practically null The action taken were delayed in spite of several red flags stemming from analyst and multilaterals The trigger was the loss of domestic and/or external financing The consequence was a sequence of debt restructuring exercises with paltry results

5 Post Restructuring Outcomes Pre Restructuring (D/GDP) Post Restructuring (D/GDP) Jamaica (2013) Jamaica (2010) Belize (2007) St Kitts and Nevis (2012) Grenada (2005) Source: IMF Staff Reports

6 Answers that may explain different results Debt restructuring to be successful has to be accompanied with Macroeconomic consolidation The revamping of the financial sector The introduction of structural reforms to facilitate economic growth. Adequate political backing The inability of the debtor s political system to take the needed actions. Lack of parliamentary majorities to approve required laws, Social opposition to accept rather drastic measures, Fear to unchained second round negative effect to the domestic financial system. External negative shocks which are out of the control of the local authorities.

7 In the good or bad states of nature in debt restructuring results, the political system is the final depositary of the quality of the results achieved. Therefore we suspect that the too little too late problem is more directly linked to political constrains than technical or institutional ones.

8 The fear to default implications Economic history also shows that there are societies that try to protect their credentials as reliable creditors by any means, in the belief that this attitude reinforce The observance of the rule law The sanctity of the contracts. The well functioning of the whole society. The capabilities to attract Foreign Direct Investment.

9 The role of Multilaterals Institutions They play a substantial role to facilitate the debt restructuring But sometimes, the dialogue with the debtor who is seeking for help becomes a little bit difficult, given: Alternative views on how to approach the problem, Different projections about relevant variables ( economic growth, fiscal deficit, real exchange rate). Fear that public money could be utilized to bail out private creditors. Lack of a program in good stance with the Fund puts more pressure in an already stressful situation, given: the disbursements from other multilaterals are stopped Induce delays in the negotiation process with creditors.

10 But there is a fine line, difficult to draw, between excessive inflexibility and the need to apply some pressure on the debtor who is reluctant to achieve debt sustainability

11 General lessons LAC s recent experience also shows that most of the debt restructuring have been conducted preemptively. Only Argentina (2003), and Ecuador (2001) were the exceptions. Some countries applied some discrimination in the treatment of bonds subject to the exchange Uruguay (2003) included all bonds, but applied discriminatory criteria to different legal jurisdictions and between short and long term maturities. Belize (2007, 2013) did not include any domestic instrument in the restructuring. Jamaica (2010, 2013) affected only the entire stock of domestic public debt In my opinion discrimination between domestic and external debt could arise a sub par outcome, because the debtor is having a short fall in tax receipts which can not cover all debt service Segmentation presents inc me transfers between creditors in different jurisdictions.

12 More general lessons (II) The setting of the optimal debt relief needed is a crucial aspect of the debt restructuring process The cost of the debt overhang is augmented as time passes by Sub par rate of growth Weakening of the bankig system Debt restructuring could have negative effects on the banking system, if they are heavily exposed to public debt. Jamaica and St. Kitts and Nevis, created reserve funds to support to solvent but illiquid institutions that might be affected by the debt restructuring outcome.

13 The ongoing debate in debt restructuring The debate on debt restructuring methods has newly awoken among country officials, creditors, and multilateral institutions (particularly the IMF) The same polar views that were un place one decade ago are again in the center of the current debate

14 The Contractual Approach Most countries engaged in debt restructuring implemented voluntary preemptive market approach strategies using CAC s. (Contractual Approach) De Brun and Della Mea (2003) using Uruguay s example and applying game theory, showed the necessary conditions to induce a positive outcome that avoids hold out problems. Good faith negotiations are also a crucial ingredient to promote an ample voting approval majority Aggregation is challenging, but recent debt restructuring results showed that this was not an un surmountable problem, and new wording for CAC;s is being proposed to neutralize some aggregation potential problems.

15 The IMF statutory approach The IMF s statutory approach,(sovereign Debt Restructuring Mechanism -SDRM), tries to circumvent The potential aggregation problems that stems from the Contractual Approach The concern about concluding timely and adequate debt restructuring to restore debt sustainability. The potential difficulties to integrate a private creditor committee given the dispersion of bond investors with different legal jurisdictions, The possibility of blocking holdout creditors and litigation against sovereign debtors.

16 The SDRM mechanism The SDRM would include a provision saying that it would be activated only at the request of a Fund member who must demonstrate that the debt is unsustainable the formation of a Creditor Committee the creation of a Independent Dispute Resolution Entity to verify claims, adopt rules regarding the voting process, certify restructuring agreements and suspend legal proceedings A termination stance that will be triggerd automatically upon the cetification of all restructuring agreements, or by notice of the activating member. An Independent Dispute Resolution Forum (IDRF) would be also created to verify claims, adopt rules regardin the voting process, etc. A detailed decision making process to select the pool of judges who could be called into service on the forum when the SDRM is activated.

17 The Creditor s Position (IIF) The creditors represented by the IIF, presented their views through a set of best practices in debt restructuring, known as Principles connected mostly with the Contractual Approach. They have opposite views vis a vis the Fund propossal in debt restructuring. Backing its position are The lessons learnt from past debt restructuring successful episodes that applied the Contractual Approach, The potential adverse markets reactions of non- negotiated deals The risl of some sort of conflict of interest during the process stemming from the Fund condition as a creditor and the availability of privileged information about the debtor.

18 Suggestions on CAC s modifications CAC is a set of contractual provisions that allow a specified super-majority of bondholders to agree to changes in key terms and conditions. CAC s exist to foster more orderly debt restructuring processes so that if the required majority agrees, a small minority cannot block the change In this regard, at least three aspects merit attention: provisions for Bond Holders Meetings, Per Series Voting, Disenfranchisement.

19 Provisions regulating bond holders meeting Reserve Matter modifications (reduction of principal and/or interest) need to be approved by an affirmative vote of bondholder s meeting satisfying minimum quorum requirements. (75% generally) One of the problems is the treatment of the non- responder to the meeting, which could be treated as though they have affirmatively voted against the proposed modifications One solution should be to introduce a modification, where the qualified vote solicitation requiring only a participant quorum of 50% of the total outstanding bonds, maintaining the 75% affirmative vote. Another alternative should be the Greek example, where the required voting threshold (two thirds) on the number of bonds that actually responded to the solicitation vote.

20 The Aggregation Clause The aggregation clause and the per-series voting were established in Uruguay s 2003 debt exchange.it hinges between two opposite facts: the amendment of certain terms for the aggregated vote of all series of the bonds the risk of imposing discriminatory terms on one bond or one type of bond. In Uruguay s case, the exchange established an 85 % threshold for the aggregated vote and also a 66.66% per series threshold

21 The 85% provision was intended as referendum on the acceptability of the proposed amendment. The 66.66% per bond approval requirement reassures holders of each series that they could not be forced to accept discriminatory terms, given the vote of a supermajority of holders of other bonds. However, that solution is imperfect since the additional investment required to buy a blocking position (at most 33.33% of one series), for a small bond trading at a heavy discount, could be negligible

22 Aggregation alternative solutions Opt-out mechanisms, requiring a certain percentage of bondholders in a per-series basis to present an explicit no vote to the amendment proposed by a supermajority. Lowering of the voting threshold in a perseries basis. Following Uruguay s debt exchange criteria, the per-series voting criterion is set at 50%, not 66.66%.

23 Bond disenfranchisement Important tool to protect bondholder s rights from decision taken by bond holders who are or are connected with the issuer. (public enterprises, state owned banks and public pension funds). To address this potential conflict of interest, all CAC s disenfranchise certain types of bonds. Uruguay applied extensively this idea in 2003, and other regional countries followed that strategy Europeans have a more flexible standing in this matter, that could generate potential discriminatory problems against private bondholders.

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