Supplementary memorandum submitted by
HM Treasury
THE IMF PROPOSAL FOR A SOVEREIGN DEBT RESTRUCTURING
MECHANISM
Because the risk of financial crisis cannot
be completely extinguished, it is essential for the international
community to ensure that effective strategies are available for
managing and resolving crises when they occur. These strategies
are aimed at ensuring the appropriate balance is achieved between
domestic adjustment, official sector inflows and private sector
involvement. The need for better mechanisms to facilitate sovereign
debt restructuring, when countries are faced with an unsustainable
debt burden, has been visibly demonstrated by recent crises, where
delays in restructuring have caused an excess loss of growth.
These delays have a number of sources. In the
recent past, instances where minority creditors have been able
to successfully litigate against sovereigns in default have introduced
an additional uncertainty into the process. The mere threat of
disruptive litigation by minority creditors creates uncertainty
about the restructuring process[10].
In addition to the uncertainty it introduces to the process, these
judgments also raise questions of whether all creditors will be
fairly treated, making creditor co-ordination problematic, resulting
in less orderly restructuring negotiations—a trend that
has been reinforced by the shift over the last decade away from
direct bank lending and towards bond issues held by a large number
of dispersed creditors. Partly because of the lack of a predictable
method of undertaking restructurings countries have also tended
to value avoidance of a restructuring too highly relative to the
potential impact on the domestic economy of default.
These practical and legal difficulties provide
an incentive to governments with unsustainable debt to avoid or
delay necessary restructurings, while the delay in turn often
results in unnecessarily painful or prolonged domestic adjustment,
in addition to a greater loss of value for investors.
The statutory approach
The Chancellor has been in the lead in calling
for more effective mechanisms to address the issues surrounding
the current process of sovereign debt restructuring, which are
described above. In November 2001, the IMF proposed the establishment
of a new Sovereign Debt Restructuring Mechanism (SDRM), with the
following main elements:
1. To prevent disruptive litigation and creditor
coordination problems from undermining agreement, debtors that
had suspended payments would be given temporary protection from
creditor litigation until a fair, sustainable resolution had been
achieved.
2. To prevent this protection being abused
by the debtor, it would be necessary to establish a mechanism
to facilitate debtor-creditor negotiations and ensure that the
debtor acts fairly and in good faith.
3. To facilitate the provision of new money,
seniority would be granted to financing extended during the restructuring
period.
4. To prevent holdout creditors from deliberately
undermining any restructuring agreement reached between the debtor
and a majority across all creditor classes of debt, the mechanism
would bind minority creditors to the agreement.
The UK, along with other G7 countries, has pledged
its support for further work to develop this proposal and at the
Annual Meetings 2002, the IMF was mandated to develop a concrete
proposal for an SDRM in time for the IMF Spring Meeting in 2003.
There are a number of complex technical, legal,
analytical and policy issues involved in designing such a mechanism
which the international community is currently trying to address,
such as:
— the appropriate scope of the debt
to be covered (i.e. the value and the practicability of incorporating
various types of debt into the mechanism);
— the nature of any stay on litigation;
— the legal changes required to give
the mechanism sufficient statutory authority;
— the impact the mechanism would have
on developing country access to capital; and
— the appropriate role of the Fund
in such a mechanism.
In answering these questions the IMF is consulting
widely with the interested parties with a view to formulating
practical solutions. It is likely that the final shape of any
proposed SDRM will be significantly different from the initial
outline proposals made in 2001.
Because of the legal changes required, it may
be impossible to establish such a mechanism quickly (although
the IMF also plays a non-statutory role in crisis resolution and
debt restructuring through its policies of lending into arrears
and access, which it is currently refining). Moreover, the mechanism
could only ever be one part of a wider framework for private sector
involvement in crisis resolution. Only in extremis should a country
embark on such a procedure, when it had become clear that the
country could no longer service its debts. The procedure could
otherwise give rise to serious debtor moral hazard problems, which
could raise emerging market borrowing costs.
However, even if rarely used, the mechanism
could considerably improve the overall effectiveness of the official
approach to private sector involvement in crisis resolution. By
establishing a credible recourse to restructuring, the mechanism
could provide the correct incentives for creditors and debtors
to find voluntary solutions to sustainability problems at an earlier
stage—a phenomenon known as "bargaining in the shadow
of the law" in a domestic bankruptcy context.
HM Treasury
December 2002
Letter sent by PSIRU (Public Services
International Research Unit) to the Rt. Hon Clare Short MP, Secretary
of State for International Development
Dear Secretary of State,
PUBLIC SERVICES
INTERNATIONAL RESEARCH
UNIT (PSIRU), UNIVERSITY
OF GREENWICH
During your oral evidence to the select committee
on 5 November, a member of the committee referred to reports submitted
as evidence to the Committee by PSIRU (Public Services International
Research Unit). The uncorrected transcript of evidence attributes
a number of comments to you, including: "Which [PSIRU] I
have never heard of, may I say, which is making false claims,
whoever they are"; later, "what they are claiming about
the World Bank is false" and finally "The organisation
is making absolutely false and untrue claims about Bank policy.
I do not respect false claims. There is a lot of campaigning that
goes on in development that seeks headlines by making false claims.
I profoundly disrespect that so when that is happening I will
say it is a false claim."
The first point is that, as you can see from
this letter, we are a research unit in the University of Greenwich,
whose work is based on empirical studies on public services, privatisation
and restructuring. Our research is respected and well received
by the academic community both in the UK and abroad: the most
recent example was at the annual meeting of the Development Studies
Association on 9 November, where a workshop on PSIRU's work was
very well attended, the presentations were received with considerable
interest and our work was described by leading members of the
DSA as extremely interesting and posing some very important questions.
PSIRU staff's work is published in academic journals in a range
of disciplines, including development studies, water, energy and
health policy and we have presented at a number of academic conferences.
We do not seek headlines, we do not issue press releases and we
hardly ever get mentioned in the media.
The second point is that the World Bank itself,
which you complain we have misrepresented, has taken our research
very seriously. The papers which we submitted to the Select Committee
were written last year as critiques of successive drafts of the
World Bank's Private Sector Development (PSD) Strategy. The World
Bank responded to these positively and with respect for the arguments
we advanced. I attended a forum in Washington last year, which
was organised specifically to debate our critiques, where Michael
Klein, the chief author of the PSD Strategy papers, conceded that
he was convinced by our arguments on risk transfer, and indeed
the next draft of that policy paper largely abandoned those arguments.
In January this year, he attended a meeting here in London, at
LSE, where he discussed the later version of the PSD Strategy
with two commentators—Professor Robert Wade of LSE and my
colleague Kate Bayliss. At no stage did he or anyone else at the
World Bank accuse us of making false claims.
In addition to this engagement with our work
on the PSD Strategy, the World Bank's Water Supply and Sanitation
Division, in February this year, recognised our work on the water
sector by inviting me to give one of the guest lectures to that
Division[11],
followed by an hour and a half's discussion of PSIRU's work in
this sector. World Bank water specialists have independently complimented
us on our work and its empirical basis.
I don't complain that you hadn't heard of us,
but I don't think it's justifiable to accuse us of making "false
claims", which is a damaging thing to suggest about a research
institute. So I hope that on reflection you can reassure the University
of Greenwich, and the Select Committee, that you did not mean
to suggest that our work is inaccurate or unreliable - only that
you have not (yet) been convinced by our arguments.
David Hall
Director
Public Services International Research Unit (PSIRU)
School of Computing and Mathematical Sciences
University of Greenwich
19 November 2002
Letter sent by the Rt Hon Clare Short
MP, Secretary of State for International Development, to David
Hall, Director, PSIRU
Thank you for your letter of 19 November 2002
about Public Services International Research Unit's (PSIRU) work,
which was raised during my House of Commons' International Development
Committee (IDC) appearance on 5 November. I note your positive
engagement with the World Bank and its development of policy in
both the areas of private sector development and of water and
sanitation, but I thought it might be useful to set out why I
was unable to agree with some of the points raised with me at
the IDC hearing.
The elimination of poverty in developing countries
requires sustained economic growth; this cannot be achieved without
the private sector. We need to harness private finance and ensure
that it works for the poor. My Department engaged closely with
the World Bank in the preparation of its Private Sector Development
Strategy earlier this year. We welcome the way it acknowledges
the primacy of country driven processes (such as Poverty Reduction
Strategies, which we have championed), balances the roles of the
state and the private sector, and stresses the need for proper
governance and regulatory reforms in the private sector. The Strategy
also advocates private provision of services when it is clear
that this is the best approach. As I made clear to the Committee,
our starting point in considering public or private basic utility
and service provision is to ask what will deliver the best service
and value for money for the poor. We find the Bank's strategy
balanced on this issue, with consideration of the most appropriate
supplier in each case, rather than a presumption that the private
sector is best. Indeed, we find that the Bank remains very engaged
with public sector development.
On the specific issue of poor countries allegedly
being forced to shoulder all the commercial risk for long-term
take-or-pay agreements with private power producers, my Department
had some initial concerns about this. However, the World Bank
has given an assurance that it has processes in place to check
the sustainability of any such agreements. We shall remain engaged
with the Bank to ensure that these processes are being followed
on a case-by-case basis and that developing country governments
get the best deals they can.
Finally, I note from the paper you submitted
to the IDC that you see the World Bank's Private Sector Strategy
as giving priority to the needs of the private sector which, you
believe, will adversely affect social provisions. As I said in
my evidence, I simply do not agree that the Strategy is all about
privatising the public utilities. During its development, my officials
were successful in ensuring that the final version gave significant
weight to proposals for improving the investment climate that
benefit small, informal and domestic firms—informal operations
by the poorest—as well as large firms and foreign direct
investment. Like my own Department, the Bank believes that there
needs to be an assessment of what is in the best interests of
each country. Also, where utilities are privatised it is important
to secure proper regulation.
I am sorry that you received what was probably
more than your fair share of my criticism of campaigners who misrepresent
the case for private sector engagement in public sector utilities
in poor countries. But as I have said, I do not agree with the
thrust of your evidence to the Select Committee.
Rt Hon Clare Short MP
8 December 2002
10 While there have been two recent cases of successful
creditor litigation involving the attachment of assets: Elliot
Associates vs. Peru; and Red Mountain Finance vs. the Democratic
Republic of Congo, there have also been many cases of out of court
settlements. The precise impact of the threat of litigation about
the outcome of the restructuring process may be difficult to quantify. Back
11
See http://www.worldbank.org/html/fpd/water/lecture.html Back
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