Paris Club Forum – “Emerging Trends and Challenges in Official Financing”
Closing Remarks by Angel Gurría, Secretary-General, OECD
Paris, 20 November 2014
(As prepared for delivery)
Ladies and gentlemen,
Fresh from the G20 Summit in Brisbane, I am delighted to be here today for this important Forum, organised jointly by the Australian Presidency and the Paris Club.
I feel well-placed to contribute to the debate today, both as Secretary-General of the OECD, which counts many Paris Club countries among its membership, and as former Foreign Minister and Finance Minister of Mexico in the mid-to-late 1990s. I have experienced two major financial crises ‘up close and personal’: the Tequila crisis and the Great Recession. I have also been at a too close for comfort distance from the ‘Tango crisis’ (editions I, II and III); the Asian troubles of 1997 and the Russian turbulence of 2008.
Past failures should have taught us important lessons about sustainable sovereign debt restructuring, but we are learning only slowly, as the ongoing Argentine saga demonstrates. This issue is not confined to emerging economies, as the Greek tragedy has shown. Amounting to €200bn, this was the biggest sovereign default of all time. It should and could have been handled better, and we are still trying to work it out!
The world of official financing has been transformed in recent decades
Let me start with a word on the transformation in the financing architecture for global development in recent decades.
For a start, there has been massive growth in private financial flows to middle-income countries (MICs) and emerging markets. For lower income countries, there is an increasing diversity of official aid, including increased South-South collaboration and, of late, a significant rise in new bond issuance by so-called frontier markets,[i] This includes new, first-time issuers in the international sovereign debt market,[ii] particularly sub-Saharan African countries.
Both demand and supply factors underpin this surge in issuers, reflecting increased investor ‘search for yield’ in a prolonged low interest rate environment globally as well as improved economic fundamentals in developing and emerging economies. In many respects, this is good news for these countries,[iii] which are now better placed to finance government investment in infrastructure and human capital at affordable rates.
But the composition of holders of sovereign debt has changed over the years: bank loan syndicates that were prevalent in the 1970s have been increasingly replaced by dispersed and diverse bondholders. This shift was first evidenced in the Mexican crisis of 1994-1995. While there are benefits to a diversified investor base, it has heightened information asymmetries and collective action problems, thereby creating major creditor coordination problems.
Sovereign debt management remains in flux and in need of policy solutions
This new context also gives rise to new policy challenges. Excessive borrowing, in particular on international markets and in foreign currency, exposes countries to various financial stability risks when the local or global economic tide ebbs.[iv]
For example, normalisation of the highly accommodative monetary policy stance in advanced markets may lead to sudden reversals of capital flows to developing countries. This could put sudden pressures on exchange rates, official reserves and bond prices. In an extreme situation, if these pressures are accompanied by a steep fall in economic growth, sovereign debt sustainability concerns could emerge, potentially triggering a sovereign debt crisis.
The crises in the 1990s prompted a debate that is still ongoing on the need for changes in how sovereign debt is restructured. New restructuring instruments should tackle information and coordination challenges and make the process less messy and less costly. This key insight from the Mexican crisis was subsequently reinforced by the Asian, Brazilian and Argentine crises.
For many reasons Argentina has not been able to re-access the international capital markets since 2001, despite debt swaps in 2005 and 2010[v]. The recent litigation – and, one might say, activist judicial interpretation of a pari passu clause – has further aggravated the Argentine case by giving unreasonable leverage to so-called ‘professional holdouts’, who hold less than 10% of the country’s outstanding sovereign debt.
This interpretation, if applied more generally, could substantially increase the leverage of hold-out creditors and complicate creditor coordination[vi]. This injects a certain degree of urgency into the debate on sovereign debt restructuring and puts it up to the global policy community to articulate a coherent response.
We need market solutions where possible, and state intervention only when necessary
In the OECD’s view, there are basically two distinct approaches to solve creditor coordination problems that could be followed:
- First, a Sovereign Debt Restructuring Mechanism (SDRM) based on a statutory approach; and
- Second, contract reform as part of an evolving market-based approach, principally through Collective Action Clauses (CACs).
Both approaches are designed to tackle collective action problems while encouraging an orderly debt restructuring process.
At the OECD, we question the effectiveness of the first approach: statutory mechanisms for restructuring sovereign debt. For instance:
- Why would a Treaty-based insolvency regime work when, as is often the case, debt restructuring cases can better be classified as ‘won’t pays’ rather than ‘can’t pays’?
- Why would bondholders voluntarily subordinate their claims to an untested regime?
- How could a statutory mechanism remain relevant given the pace of financial innovation and structural change in official financing?
- How could we satisfactorily coordinate the conflicting interests of countries and investors under a statutory mechanism if parties are then likely to try to circumvent it after the fact?
Indeed, these are some of the reasons why both borrowers and lenders rejected the IMF’s proposal for a Sovereign Debt Restructuring Mechanism a decade ago.
Instead, the OECD would suggest that a market-based mechanism is the best approach. Central to this must be Collective Action Clauses designed to align creditors towards a workable debt restructuring proposal. To make CACs relatively immune to unreasonable leverage by holdouts, and amend or clarify the pari passu – or equal treatment clause to allow contracting parties to ensure that courts do not order debtors to pay holdout creditors whenever they pay restructured creditors.[vii] This would ensure that equal treatment does not necessarily mean equal payment, because amended or clarified pari passu clauses would clearly exclude ratable payment injunctions. Mexico recently decided to adopt these two types of changes for use in its new sovereign debt contracts.[viii]
But the aim would not be to eliminate holdouts at all costs, as this could undermine the very viability of sovereign financing in its current form. Creditors – including holdouts – should retain a meaningful voice. Contracts should therefore include thresholds so that there is some reasonable blocking capacity for creditors who wish to stay out.
For example, recent bonds issued by Kazakhstan and Mexico include new CACs that would compel all bondholders to accept restructuring terms if at least 75 % agree.[ix] For its part, the International Capital Market Association has recently endorsed the aggregation of CACs in this manner. This is a workable, common-sense approach that would retain the essence of the current system while ironing out the kinks. The next step would be to include other government liabilities, guarantees and trade credits in the aggregation process.
Ladies and gentlemen:
In an interconnected world, policy challenges are increasingly international in nature. These global challenges need a global response, and the G20 is at present the premier forum for coordinating these policy solutions. Recognising the urgency injected into this debate by recent judicial developments, the G20 has stepped up to the plate.
The Brisbane communiqué welcomed “international work on strengthened collective action and pari passu clauses”, called for “their inclusion in international sovereign bonds” and encouraged “the international community and private sector to actively promote their use”. So, we will play our part, but the ball is in your court!
The OECD will continue to work with our Member and Partner countries, with private sector stakeholders, and through the G20, with the incoming Turkish Presidency. Together, let’s strive for win-win solutions for debtors and creditors alike, for sustainable global development, and for better official financing policies for better lives.
[i] Although lower-income countries (LICs) generally rely more on official financing flows (in particular official development aid) than middle income countries, new bond issuance by the so-called frontier markets has risen significantly of late.There is no formal definition of a frontier market but coverage is fairly wide encompassing in broad terms smaller, non-traditional markets, characterised by underdeveloped local currency bond markets. Frontier markets are sometimes also characterised by less sophisticated legal and institutional frameworks and often heavy restrictions on foreign portfolio investment.
[ii] Since 2004, 26 sovereigns have issued for the first time in international bond markets, for a total amount of approximately USD 17 billion (denominated primarily in USD but also in EUROs).
[iii] New sovereign bond issuance by 39 emerging market and developing countries rose by 7.4% in 2012 and by 3.4% in 2013 (to USD 74 billion). The African continent has been particularly active. African sovereigns raised a record 11 billion in 2013 and are likely to issue even more this year.
[iv] These risks can manifest themselves via such channels as interest rate risk, exchange rate risk and refinancing risk.
[v] Argentina defaulted twice on its sovereign debt since the beginning of the 21st century– first in December 2001, when it declared a default on its sovereign debt of USD 81 billion, and, more recently, in July 2014, on its restructured bonds, issued as part of the process to resolve the first default. In spite of debt swaps in 2005 and 2010, Argentina has not been able to re-access the international capital markets since 2001. Recent litigation has further aggravated the Argentine situation, and perhaps future restructuring cases, by increasing the leverage of so-called ‘holdouts’
[vi] The IMF has noted in this context: “Ongoing litigation against Argentina could have pervasive implications for future sovereign debt restructurings by increasing leverage of holdout creditors.”(IMF, Sovereign Debt Restructuring – Recent Developments and Implications for the Fund’s Legal and Policy Framework, April 26, 2013).
[vii] The new redesigned framework recently proposed by the International Capital Market Association (ICMA) for dealing more smoothly with sovereign defaults is a good example of a market-based approach to contract reform.
[viii] Elaine Moore (2014), Mexico’s move to shake up bond markets, Financial Times, November 11.
[ix] Elaine Moore (2014), Mexico’s move to shake up bond markets, Financial Times, November 11.