Group of Ten - The resolution of sovereign liquidity crises
August 1997
EXECUTIVE SUMMARY
- Following an invitation to the Ministers and Governors of the Group of Ten by
the Heads of State and Government of the Group of Seven in Halifax in June
1995, the Deputies of the Group of Ten established a Working Party to consider
the complex set of issues arising with respect to the orderly resolution of
sovereign liquidity crises. While taking a comprehensive view of the problem,
the Working Party focused its attention on those forms of debt to private
creditors, such as internationally traded securities, that have increased in
importance in the new financial environment but that in the past have usually
been shielded from payments suspensions or restructurings. In carrying out its
work, the Working Party recognised that the highest priority needs to be given
to measures that will help prevent crises from occurring and endorsed efforts
underway in other forums to improve market discipline and strengthen the
surveillance of sovereign borrowers' economic performance. It attached
particular importance to the need for sovereign borrowers to make timely
changes in their economic policies if conditions change in ways that may lead
to reductions in capital inflows.
- After careful review of analyses of the full range of questions involved, and
taking into consideration surveys of the views of market participants and of
legal practices relating to collective representation of debt holders that were
conducted by its members for this purpose, the Working Party reached the
following broad conclusions.
- First, it is essential to maintain the basic principles that the terms and
conditions of all debt contracts are to be met in full and that market
discipline must be preserved. However, in exceptional cases, a temporary
suspension of debt payments by the debtor may be unavoidable as part of the
process of crisis resolution and as a way of gaining time to put in place a
credible adjustment programme.
- Second, neither debtor countries nor their creditors should expect to be
insulated from adverse financial consequences by the provision of largescale
official financing in the event of a crisis. Markets are equipped, or should be
equipped, to assess the risks involved in lending to sovereign borrowers and to
set the prices and other terms of the instruments accordingly. There should be
no presumption that any type of debt will be exempt from payments suspensions
or restructurings in the event of a future sovereign liquidity crisis.
- Third, current flexible, case-by-case practices and procedures, as they have
evolved over the years, are an appropriate starting point for approaches to
sovereign liquidity crises. They emphasise the importance of adjustment efforts
of the debtor country and place principal responsibility for workouts on the
debtors and creditors, with the debtor country having primary responsibility
for setting the process on a cooperative footing. Improvements in practices and
procedures should continue to be evolutionary.
- Fourth, international bankruptcy procedures and other formal arrangements do
not appear to provide, in current circumstances or in the foreseeable future, a
feasible or appropriate way of dealing with sovereign liquidity crises.
However, further study by private sector entities may be warranted.
- Fifth, further consideration should be given in appropriate forums to ways in
which financial systems in emerging market economies could be strengthened in
order to reduce the risks they might pose in the event of a sovereign liquidity
crisis.
- Sixth, a market-led process to develop for inclusion in sovereign debt
instruments contractual provisions that facilitate consultation and cooperation
between debtors and their private creditors, as well as within the creditor
community, in the event of crisis would be desirable. Market initiatives would
deserve official support as appropriate.
- And seventh, note was taken of current policies of the IMF that provide, under
exceptional circumstances, for lending in support of effective adjustment
programmes prior to full and final resolution of a sovereign borrower's arrears
to private creditors. It would be advisable for the IMF Executive Board to
review existing policy in this area and to consider whether the scope of its
application should be extended to other forms of debt not now covered, while
remaining mindful of the need for prudence and the maintenance of strict
conditionality.
- The thinking of the Working Party was influenced by three basic changes in the
financial environment bearing on the character of potential future sovereign
liquidity crises. First, the broader and stronger linkages among domestic and
international financial markets mean that crises can erupt much more quickly in
today's markets and can be far larger in scope than in the past. Second, flows
of capital to emerging market economies in the form of purchases of securities
have increased greatly in size over the years and have substituted for other
types of private capital. Third, when a crisis occurs new finance is unlikely
to be forthcoming from those who undertook the original lending. These changes
mean that financing available from official sources is less likely to be
sufficient to enable a sovereign debtor experiencing a crisis to meet fully its
external financing obligations. In any event, the Working Party stressed that
provision of official funds to limit private losses raises serious moral hazard
risks and could interfere with market discipline.
- In considering means to deal with future sovereign liquidity crises, the
Working Party was of the view that no single pre-set procedure can be suitable
in all cases. However, it identified a broad set of desirable principles and
features that provide a framework for the development of procedures for
handling sovereign liquidity crises in a flexible, casebycase approach in light
of the conditions prevailing at the time, the nature and the intensity of the
crises, and the circumstances of the debtor. Any such procedure should have the
following features.
- It should foster sound economic policies by all debtors.
- It should minimise moral hazard for both creditors and debtors.
- It should rely on market forces and not interfere with the efficient operation
of secondary markets in relevant debt instruments.
- It should limit contagion from one debtor's problems to other countries.
- It should support credible and sustainable actions and, to this end, not impose
excessive social, political, or economic costs on the debtor.
- It should seek to ensure that burdens associated with the provision of
exceptional financing are allocated fairly within and across different classes
of creditors.
- It should strengthen the ability of governments to resist pressures to assume
responsibility for the external liabilities of their private sectors.
- It should be suitable for quick and flexible use in a variety of different
cases.
- It should be cooperative and nonconfrontational, and promote the adoption by
debtors and creditors of arrangements to facilitate resolution of liquidity
crises should they occur.
- It should build on existing contractual or other arrangements that facilitate
the resolution of crises.
- It should make use of existing practices and institutions.
- The Working Party concluded that the establishment of a formal international
bankruptcy procedure would not be feasible or appropriate under present
circumstances or in the foreseeable future. Sovereign debtors have not in the
past had a strong need for legal protection against their creditors, nor could
they be obligated to submit to the jurisdiction of a bankruptcy forum. However,
the Working Party noted that interested private parties might wish to continue
to study the merits of bankruptcy or other formal procedures. At the same time,
the Working Party concluded that it is not possible or desirable to preclude
official involvement altogether in the event of a serious crisis. The official
community's interest in containing systemic risk and its role as a lender to
sovereign borrowers mean that it is has a stake, and therefore a role to play,
in fostering cooperative efforts by debtors and creditors to contend with
unexpected payments problems.
- In considering specific ways to facilitate resolution of sovereign liquidity
crises, the Working Party took the view that current practices are an
appropriate starting point. Current practices were developed over the course of
the past few decades to contend with real world problems in a pragmatic and
flexible manner. They are voluntary and make use of market information and
market forces. The practices recognise the distinct perspectives of the three
main actors involved in a crisis - the official community, private creditors,
and the sovereign debtor - as well as their common interest in the orderly
resolution of the crisis. They involve national authorities and multilateral
institutions but place principal responsibility on the individual debtor and
its creditors. The practices are based on the implementation of an
IMF-supported sustainable adjustment programme as a major precondition for the
cooperative resolution of a crisis.
- The Working Party recognised that structural weaknesses in the banking systems
of debtor countries could seriously aggravate liquidity crises and might pose
difficulties for financial systems in lender countries. The Working Party
concluded that further work should be undertaken in appropriate international
forums to promote the strengthening of financial systems in emerging market
economies and thus help to reduce such risks.
- The Working Party took the view that certain contractual or statutory
provisions governing debt contracts can facilitate the resolution of a crisis
by fostering dialogue and consultation between the sovereign debtor and its
creditors and among creditors, and by reducing the incentive for, or ability
of, a small number of dissident creditors to disrupt, delay or prevent
arrangements to support a credible adjustment programme that is acceptable to
the vast majority of concerned parties. Among such provisions are those that
(a) provide for the collective representation of debt holders in the event of
crisis, (b) allow for qualified majority voting to alter the terms and
conditions of debt contracts, and (c) require the sharing among creditors of
assets received from the debtor. Such clauses have been employed in a limited
set of debt contracts. The Working Party emphasised that evolution of
contractual arrangements between sovereign borrowers and their creditors needs
to be a market-led process if it is to be successful. Such efforts should
receive official support as appropriate.
- The Working Party strongly endorsed the fundamental principle that the terms
and conditions of all debt contracts are to be met in full and on time. At the
same time, it recognised that in certain exceptional cases the suspension of
debt payments may be a necessary part of the crisis resolution process. Such
payment suspensions should be non-confrontational and implemented in a way that
does not hamper the operation of secondary markets. The Working Party did not
consider that it would be feasible to operate any formal mechanism for
signalling the official community's approval of a suspension of payments by the
debtor. Although the Working Party rejected any formal international approval
of a suspension of debt payments, it concluded that it would be advisable for
the IMF Executive Board to consider extending the scope of its current policy
of lending, in exceptional circumstances, to a country that faces the prospect
of continuing to accumulate arrears on some of its contractual debt-service
obligations to private sector creditors, in cases where the country is
undertaking a strong adjustment programme and making reasonable efforts to
negotiate with its creditors. Such lending can both signal confidence in the
debtor country's policies and longer-term prospects and indicate to unpaid
creditors that their interests would best be served by quickly reaching an
agreement with the debtor.
- The Working Party reached the overall conclusion that there is no need to
change current procedures for official bilateral credits and long-term bank
claims. However, there is a need for the principles and procedures for handling
sovereign liquidity crises to take into account the new importance of debt in
the form of securities and the growing likelihood that some such debt may have
to be subject to renegotiation in the future. While the official community may
be able to facilitate dialogue and assist in data collection, market
participants should make the decisions regarding any innovations in contractual
provisions. The official community's primary role in the resolution of
sovereign liquidity crises should remain centred on the promotion of strong and
effective adjustment by debtor countries in the context of IMF-supported
programmes, which would need to take into account any recourse to temporary
suspensions of payments.
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