Debt Restructuring and

Rescheduling
National Workshop on Capacity-Building For
External Debt Management in The Era of
Rapid Globalization
August 30 – 31, 2005

Francis Odubekun
Government Debt Issuance & Management Advisor
US Treasury Department – Office of Technical Assistance
1
 Debt Rescheduling
 Debt Rescheduling - a form of debt re-organization in
which debtors and creditors negotiate to defer payments
of principal and/or interest falling, due in a specified
interval for repayment on a new schedule.
 The term “Restructuring” is used to include the
rescheduling of interest and principal payments as well as
a write-down on the debt principal or interest rate.
 Conventionally, Debt Restructuring is the process of
rescheduling medium- to long-term debt maturities or
refinancing short-term debts and/or interests.

2
 Historical Perspective
 Debt has been the largest source of capital flows to
developing countries in the past 50 years.
 Lending increased drastically starting in the 1970s,
and today the total external indebtedness of
developing countries is close to $3 trillion –
representing about 42.5% of their GDP.
 Long-term foreign debt owed or guaranteed by
governments is $2.2 trillion or 75% of all long-term
debt.
 Given their weak economies, developing countries
have found it difficult to service such debts.
3
 International Debt Crises
 Long history of sovereign debt problems and crises.
Includes advanced economies.
 During 1930s Great Depression, both the U.K. and
France defaulted on their debts.
 During latter 1900s, Latin America became more
associated with debt payment problems,
 1914 - Mexico suspended its debt payments.
 1956 – Following Argentina’s debt problems, a
group of wealthy industrialized nations met in Paris
to develop a solution to problems in Argentina - led
to what is now known as the “Paris Club”.
 Since the first case involving Argentina in 1956,
Paris Club has reached 347 agreements concerning
77 debtor nations
4
 80s & 90s
 Following huge lending increases in lending in the
mid-1970s, mainly in the form of syndicated bank
loans, debt crises swept through developing world,
starting with Mexico in August of 1982.
 1994 - “Tequila Crisis” started in Mexico - spread
through Latin America and other parts of the
developing world.
 1997/98 - debt crisis in East Asia
 1998 - Russian default
 2001 - Turkey
 2002 - Largest sovereign default in history occurred
when Argentina defaulted on U$141 billion of public
debt.
5
 MOVE FROM BANK LENDING TO
LARGE-SCALE BOND ISSUANCE
 Throughout this debt crisis prone period, there
were many efforts to restructure sovereign
debts,
 Each effort was a problem in itself.
 This problem became greater with the
introduction of bond lending.
 Whereas the restructuring of official debt and
syndicated bank loans involved sometimes
dozens of lenders, the introduction of bonds
expanded the base to involve hundreds if not
thousands of creditors.
6
Short-Term Objectives Of Debt
Restructuring
Solve The Liquidity Crisis By:
 Deferring or refinancing most current debt
maturities
 Spreading bunched maturities over several years
Provide New Credits To
 Ease the liquidity crisis
 Finance imports essential for producing exports
that will generate foreign currency

7
MEDIUM TO LONG-TERM OBJECTIVES OF
DEBT RESTRUCTURING

 Avoid a further liquidity crisis.

 Mitigate and eventually eliminate the crisis
atmosphere.
 Restore a climate in which the sovereign may
operate normally in the international credit
markets.

8
What Factors Force States To
Reschedule Debts ?

Origins of the Crisis

 Originated in the mid-1970s, following oil price
shocks
 High prices for commodities

 Overly optimistic assumptions about economic

growth
 Declining terms of trade

 Inappropriate domestic economic policies

 Petro-dollar recycling

 Excessive military expenditure contributed to the

building crisis
 Corruption
9
 What Factors Force States To
Reschedule Debts ?
 Low interest rates led many countries to contract loan
obligations which proved unsustainable when
conditions took turn for worse
 By early 1980s, commodities prices fell sharply
 As real interest rates rose, many developing countries
had difficulties in meeting their obligations
 Global recession
 Some countries were successful in responding to these
problems, others could not adjust quickly enough
 Debt crisis erupted in 1982, when Mexico announced
that it was no longer able to service its foreign debt.
10
EARLY APPROACHES TO THE
DEBT CRISIS
 Large middle-income countries owed much of
their debt to major commercial banks
 At first, there was real concern that a default
would undermine the international banking
system
 Debt often exceeded the capital base of
many of these international banks
 International financial community feared that
the banking system would collapse
11
Liquidity vs. Solvency Problems

 Initially, it was believed that the debt crisis was

due to short-term liquidity problems.
 Assumption was that short-term debt relief,
such as extended repayment periods,
combined with new money and macroeconomic
adjustment would return countries to
creditworthiness and enhance their ability to
finance economic growth

12
 EARLY APPROACHES TO THE DEBT
CRISIS
 Focus was on re-scheduling large, middle-income countries such as
Brazil and Mexico, as they presumably posed the greatest threat to
the world financial system
 Later realization of the uniqueness of each debtor country's debt
situation, economy, and debt service capacity, creditor governments
agreed to manage the debt crisis on a case-by-case basis
 Became evident that many debtors' economic problems were more
structural than had been assumed and required a longer-term
response from debtors and creditors alike
 Meanwhile, private capital from within these countries fled abroad
seeking greater and more secure rates of return. This Capital flight
exacerbated debtors' difficulties.

13
Baker Plan
 In 1985, the Baker Plan embraced a new
strategy for managing the debt of middle-
income countries. It analyzed a debtor
country's adjustment program, then increased
bank lending to support policy efforts while
continuing to monitor the results through the
IMF.
 Baker Plan made new money available to
sustain levels of investment necessary to
restore growth and allow the major debtors to
outgrow their debt
14
The Brady Plan
 The Brady Plan acknowledged the need to combine
the objectives of the debt strategy with those of
development policies.
 First among the Brady Plan's innovative elements
was its explicit recognition of the need for
commercial debt reduction and for reducing debt
service.
 Secondly, the Brady initiative made IMF and World
Bank funds (as well as contributions by
governments, particularly, that of the Japanese)
available to support debt reduction operations.
15
Brady Plan
 In May 1989, IMF Board agreed to guidelines
defining its role in the new third world debt
strategy.
 Guidelines provided for separate funds to be
devoted by the IMF to debt reduction
 25% of a country's extended fund facility or
standby loan arrangement to be "set aside" and
 Up to 40% of a debtor country's quota to be
devoted to interest support

16
 Brady Plan

 The Plan recognized the need to loosen

legal, regulatory, tax, and accounting
constraints that limited the possibility of
debt/debt service reduction.
 required banks to waive provisions such as
sharing and negative pledge clauses in existing
agreements
 mandated a review of creditor countries'
regulatory, accounting, and tax provisions to
eliminate disincentives (or create incentives) for
debt reduction
17
 Mexican Brady Plan

 Mexico's debt deal was the first comprehensive deal within the Brady
initiative. Banks involved in the negotiations had three options.

 First, banks could exchange old loans for new bonds at a discount of
35% of their face value, keeping interest rates at market levels
(equivalent to LIBOR + 13/16bps)

 Alternately, the banks could exchange old debt for face-value new
bonds (called par bonds) bearing fixed interest rates of 6.25%.

 The third option was a provision of new money, equivalent to 25% of

the banks' medium- and long-term loans.

 (Both of the first two options reduced interest payments.)

18
 Mexican Brady Deal

 Both options also provided for 30 year bonds, whose principal was
guaranteed (collateralized) with loans provided by the IMF, World
Bank, Japan, and Mexican reserves used to purchase U.S. Treasury
zero-coupons

 The bonds had 30 year "bullet" maturities - no annual amortization

payments, and principal was repaid only at the end of 30 years -
which also reduced debt service

 Official support also guaranteed interest payments for 18 months

(rolling)

 Mexico's bonds also included a novel value recovery clause linking

debt service payments to oil prices, the country's main source of
foreign exchange

19
Mexican Brady’s “Value Recovery Clause”

 From July 1996 onwards, if the oil price

surpassed the barrier of U.S. $14 dollars per
barrel (adjusted for U.S. inflation), up to 30%
of the additional revenues would accrue to
creditors.
 This additional payment, however, could not
exceed 3% of the nominal value of the debt
converted into new bonds.

20
 Mexican Brady Deal

 When Mexico signed the deal, its total debt stock was U$95.6 billion
 Only the share of the long-term debt with the commercial banks was
subject to restructuring.
 The debt value involved in the agreement was about U$49 billion,
roughly half of the total debt
 Principal reduction = $19.7 billion (40%)
 Interest reduction = $22.8 billion (47%)
 New money = $6.4billion (13%)
 Most banks opted for the par bond, implying interest rate reduction
($22.8 billion, or 46.7% of the total).
 Other banks ($19.7 billion, or 40% of the total) chose to reduce the
principal;
 A few offered new loans ($6.4 billion, or 13.1% of the total).

21
 Debt Conversion Programs

The Brady Plan proposals recognized that the

debtors had to adopt policies to attract both
direct and indirect investment and that
debt/equity swaps could be a useful
component of such a strategy.
 Several Latin American countries used other

debt conversion mechanisms, such as debt

buy-back and debt-for-nature swaps.

22
 Debt Conversion Programs

 A debt-equity swap converts a developing country's

debt into equity via foreign investment (direct or
portfolio) in a domestic firm.
 Once the project is approved, the company purchases
the developing country's foreign debt on the secondary
market at less than its full face value.
 Recently, several developing countries have used
extensive conversions of private commercial debt to
promote foreign investment, reduce debt, conduct
privatization and further other development objectives

23
 Debt /Equity Swap

 The central bank of the host country redeems the debt in local
currency, usually at an implied exchange rate somewhere between
the face value and the secondary market value of the paper.
 The foreign company uses this local currency to make the approved
investment via purchase of shares or an injection of capital.
 According to IMF research, an estimated U.S. $33.6 billion of
commercial debt was extinguished through ongoing official
commercial debt conversion programs between 1985 and 1990.
 Chile demonstrates an impressive example, where the conversion of
almost 70% of the commercial debt in 1985 overcame the debt
overhang significantly and helped the country return to international
capital markets. .
 Several Latin American countries have successful debt-equity
programs

24
 DEBT CONVERSION PROGRAM
RESULTS
Positive Debt Conversion Results Include:
 Major reduction in commercial debt

 Investment promotion and return of flight capital

 Export promotion and import substitution

 Privatization

 Strengthened private sector finance

 Debt conversions can help catalyze FDI flows

25
 OTHER DEBT RESTRUCTURING ISSUES
 While some countries have survived the crisis, many others, despite their
efforts, show clear signs that the debt burden is intolerable and its servicing
requirements exorbitant.
 Obviously, the poorest and most heavily indebted countries have different
needs than lower-middle-income debtors. The debt problem of the poorer
developing countries was qualitatively different from that of the large middle-
income countries.
 Many of the debt-distressed poor countries had a larger debt burden in
relation to their economic size and potential.
 Moreover, these countries relied heavily on the export earnings of one or two
commodities.
 A significant decline in the terms of trade for these commodities severely
disrupted the countries' capacity to service debt or resume growth.
 Recent developments combine the goals of debt relief and development
 Because the commercial debt of the poorest countries is small in absolute
terms, future measures to help these debt-distressed countries must
emphasize grant or highly concessional external finance as well as greater
debt reduction.
 Consensus that creditors should afford the poorest debtors even more
generous terms
26
OTHER DEBT BURDEN ALLEVIATION
PROPOSALS

Under The "Enhanced Toronto Terms”

Creditors Can Opt To:
 Cancel 50% of eligible maturities being

consolidated
 Have interest rates on non-concessional debt.

Further stretch export credit and concessional

debt repayments
 Capitalize reduced interest rates to equalize

net present value (NVP) terms with the other

options.
27
 OTHER DEBT BURDEN
ALLEVIATION PROPOSALS
TRINIDAD TERMS SUGGESTED:
 Rescheduling the entire stock of debt for maturities
falling due in 15 to 18 month intervals, instead of re-
negotiation tranche by tranche.
 Increasing the amount of relief provided by debt stock
cancellation from 1/3 to 2/3.
 Capitalizing for 5 years interest payments on the
remaining 1/3 of the debt stock and requiring phased
repayment with steadily increasing payment based on
export and output growth in the debtor economy.
 Stretching repayment of the remaining 1/3 stock over
25 years.
28
 OTHER DEBT RESTRUCTURINGS

 During the mid-1980s, larger middle-income

countries received better terms than most sub-
Saharan African countries.
 As a result, many countries "left out" of the
Baker initiative have had to seek other forms of
debt rescheduling and relief.
 E.g., the London Club is one alternative.

29
Role of Paris & London Clubs

 The Paris Club and the London Club are the

two principal frameworks for restructuring (or,
more practically, for rescheduling) sovereign
debt.
 Each club has a set of rules and procedures
used for rescheduling operations.
 In general, the Paris Club reschedules debts
owed to official creditors, whereas the
London Club reschedules debts owed to
commercial banks
30
Paris Club

The Paris Club is an informal forum where

countries experiencing difficulties in paying
their debts to governments and private
institutions meet with their creditors to
restructure these debts. Paris Club is
 not a club,
 not a formal international organization.
 has no offices or secretariat,
 has no charter.
 ad hoc institution with no legal status.

31
 LONDON CLUB
 A forum for rescheduling credits extended by
commercial banks (without a creditor-government
guarantee).
 Negotiations often take place in London,
 Informal body comprising commercial banks exposed to
third World debt.
 Like Paris Club, the London Club works to reduce
developing countries' immediate debt servicing burdens.
 “Membership" is fluid
 No formal mandate.
 In the London Club, the interests of the creditor banks
are represented by a steering committee composed of
those banks with the greatest exposure to the debtor
country in question.
32
 London Club
London Club reschedules commercial debts
debts
The interests of the creditor banks are
represented by a steering committee
composed of those banks with the
greatest exposure to the debtor country
in question
As a rule, the London Club does not
reschedule interest payments, instead,
commercial banks provide the country
with a "new money" loan as part of the
rescheduling package.
London Club generally refuses consolidation
periods of more than one year
London Club may reschedule a debt without
requiring the debtor nation to conclude a
standby agreement with the International
Monetary Fund (IMF).
London Club debtors enjoy more flexibility,
but incur more expense, than their Paris
Club counterparts.
Paris Club
The Paris Club reschedules debts
owed to official creditors.
In the Paris Club, more often than
not, the creditors are
represented by the most
influential among them,
regardless of their relative
stake in the restructuring in
question
Paris Club reschedules both
principal and interest
Whereas the London Club prefers
them to exceed two or three
years, however, the Paris
Club has slowly expanded its
consolidation periods
Paris Club requires an IMF
arrangement
33
 STEPS INVOLVED IN A LONDON CLUB
RESTRUCTURING

Seven steps involved in a London Club

Restructuring:
3. First, the debtor declares a moratorium on payments,

4. Forms a debt management team, and

5. Drafts an information memorandum.

6. Simultaneously, the creditors form a steering

committee or bank advisory committee (BAC).
7. The parties convene at the exploratory meeting.

8. They then negotiate the heads of terms (hot) and,

9. Document the rescheduling agreements.

34
THE ROLE OF THE IMF AND WORLD BANK

 Throughout the 1980s, the multilateral financial

institutions became increasingly involved in resolving
the debt crisis.
 The role of the International Monetary Fund (IMF) is
to preserve the financial integrity of the world
monetary system and to provide balance of
payments assistance to countries experiencing debt
service difficulties.
 the IMF attempts to hold the appropriate balance
between the adjustment effort required from the
debtor countries and the commitment of new external
finance from the commercial banks and official
creditors
35
THE ROLE OF THE IMF

 Assist in formulating adjustment programs

that incorporate performance criteria from
debtor countries' upper credit tranche
drawings.
 Provide stand-by facility or extended fund
facility.
 Act as a catalyst in facility or external funds
from commercial B banks.
36
 THE ROLE OF THE WORLD BANK

 World Bank and other regional institutions) provide

concessional and non-concessional finance for
development purposes.
THE ROLE OF THE WORLD BANK
 Support debtors' stabilization programs.

 Establish structural adjustment lending programs.

 Mobilize funds from other sources for future

development of debtor countries.

 Provide technical assistance in debt management.

37
 IMF

 Every debt rescheduling exercise, requires a

debtor country to have an IMF program or a
similar adjustment program in place.
 Before creditors enter any serious rescheduling
negotiations, the IMF must confirm that the
debtor is pursuing an economic program that
would set it on the path to recovery.
 Creditors adopted this policy in response to their
perceived helplessness in monitoring the
economy of debtor countries.
38
 SUMMARY
 Creditors and debtors may view progress in
dealing with the debt problem differently.
 From the creditors' point of view, the strategy
seems to be quite successful.
 A disruption of the financial system has been
avoided,
 debt is being serviced in most cases,
 banks have managed to reduce their exposure, and
 debtor countries are pursuing sound adjustment
programs.
 Debtors, however, give a less positive
evaluation of the debt strategy.
39
NEW PROPOSALS FOR SOVEREIGN DEBT
RESTRUCTURING

 Irrespective of the outcome of the debate over

whether such borrowing has been useful, it remains
a fact that the debt build-up has led to repayment
problems and in some cases default.
 The current framework for addressing default,
bankruptcy and debt restructuring has proven to be
inadequate in sorting out these problems.
 Several efforts underway to establish a new and
more effective restructuring process.

40
 NEW PROPOSALS FOR SOVEREIGN DEBT
RESTRUCTURING
 While the restructuring of official debt and syndicated
bank loans involved sometimes dozens of lenders, the
use of bonds involves hundreds if not thousands of
creditors.
 Widespread agreement for the need for a sovereign
debt restructuring process,
 Disagreement over what the actual process should be.
 A framework will need to protect the rights of creditors
and debtors, and protect debtors from civil law suits
during the structuring process.
 Process should prevent rogue vulture hedge funds from
delaying or otherwise disrupting the restructuring
process and from profiting from others’ efforts to forgive
and restructure outstanding debt.
41
 Three Basic Approaches
• SDRM proposal calls for the creation of an
institution to act as an arbiter in a new
formalized process which would work along
the lines of an international bankruptcy court.
• “Collective Action Clauses” to allow a majority
of creditors to set the terms of restructuring
• Adapts U.S. sovereign bankruptcy law, known
as “Chapter 9”, to the needs of developing
countries

42
SOVEREIGN DEBT
RESTRUCTURING MECHANISM

Four “core features”:

 Majority rule (as opposed to unanimity) in

restructuring decisions,
 A legal “stay” against claims by creditors,

 Protection of creditor interests, and

 Priority financing.

43
 Collective Action Clauses

 Focuses on the writing of bond and loan contracts to

include clauses that would prevent a minority of
creditors from blocking negotiations with the debtor.
 Decentralized market-oriented approach, as opposed
to the centralized non-market approach of SDRM.
 Collective Action Clauses (CACs) would bind in a
minority (and therefore, any vulture funds) and allow a
majority vote (usually a super-majority of 60% to 75%)
to determine the outcome of a restructuring agreement.
 The principal shortcoming with this approach is that
CACs can only be included in future debt,
 The enormous amount of currently outstanding debt
would not benefit from their inclusion.
44
 Holdout Creditors

 Further complicating matters is the fact that some

creditors might not be willing to relinquish their
contractual rights.
 These holdout creditors can refuse to participate in the
restructuring and/or accept a rescheduling of debt.
Rather, they demand payment according to the terms
set forth in the original bond.
 The situation has been exacerbated by the aggressive
legal strategies employed by so-called “vulture funds,”
which buy distressed sovereign debt on the secondary
market and then sue for contractual interest and
principal payments.
 The case of Peru’s debt restructuring illustrates the
litigious holdout creditor problem to date
45
 Issues of Legal Jurisdiction
 Even if CACs are employed in all new debt issuances
and this effectively creates a new universal legal
framework, there will still not necessarily be a uniform
interpretation;
 It will be up to individual jurisdictions to interpret the
clauses, according to their domestic law.
 Central to the holdout creditor problem is the question of
jurisdiction. The governing law often determines whether
or not creditors may vote to alter the payment terms of
the bond.
 Either English or New York law governs most sovereign
bonds

46
 English vs. New York Law

 Under English law, any provisions, including

terms of payment, can be changed via
supermajority vote (usually 66⅔% or 75%).
 A majority of creditors can impose a restructuring on
the holdout creditor, which eliminates the holdout’s
ability to disrupt the process.
 Bonds governed by New York law, on the other
hand, have a unanimity requirement.
 Payment terms of the lending agreement cannot be
changed unless 100% of bondholders agree to the
new arrangement
47
 Exit Consents
 The desired effect is to provide a disincentive to
holdouts.
 After the details of the debt restructuring are
negotiated, creditors exchange their old bonds for new
issues.
 As the exchange is taking place, creditors agree to alter
certain clauses of the original bonds to make them less
attractive.
 E.g., The old bonds might be de-listed from the
exchange on which they trade, making them illiquid, or
have the waiver of sovereign immunity removed.
 In the us corporate context, exit consents have
successfully “coerced” unwilling creditors to accept an
exchange offer.
48
 CHAPTER 9 OR FTAP

PROPOSAL
Third proposal for a better restructuring framework proposes that
Chapter 9 of U.S. bankruptcy law be applied internationally to
sovereign debt.
 Chapter 9 functions in the U.S. to protect the rights of indebted
municipal governments and public agencies in order to protect the
rights of taxpayers and public sector employees, and allows for their
full participation in, and ability to object to, the outcome of a debt
rescheduling process.
 Would allow an indebted nation to file for a stay.
 As with the SDRM proposal, there will need to be a third party body
to be put in place to resolve the conflict between the debtor and
creditors.
 Unlike the permanent DRF, this body is proposed to be ad hoc,
appointed with each petition for a stay, and also is to act as
arbitration panel.

49
THANK YOU

50