Historic agreement paves the way for just response to sovereign debt crises (September 2014)

Rethinking Bretton Woods | Tue, Sep 16, 2014

By Aldo Caliari

This article reports on recent developments on the search for sovereign debt restructuring mechanisms in relation to the longstanding plea by debt justice campaigners.


In June of this year, the US Supreme Court extinguished the last hope that a US judge’s ruling handing  “vulture funds” a victorious precedent to sue poor countries and make extraordinary profits at the expense of debt relief granted by other  creditors, could be reversed.

Less than three months later, debt justice campaigners had reason to celebrate that something good may come out of it, after all. The UN General Assembly, in a historical vote held on September 9th, adopted a resolution to initiate negotiations towards a multilateral legal framework on sovereign debt restructuring.

The ruling had been part of a case “vulture fund” NML initiated against Argentina. This fund had acquired Argentine sovereign debt bonds after the 2002 default and had not accepted the terms of the agreement reached by Argentina with over 92 per cent of the bondholders in 2005 and 2010, and sued in US courts for payment of a 100 per cent of the instruments value plus interest aiming to achieve what, at the current moment, represents a 1600 per cent return on their original investment.

The US judge with jurisdiction on the case decided to depart from the traditionally accepted understanding of the “pari passu” clause –a clause typically inserted in sovereign bonds. He interpreted the standard pari passu clause (normally understood to grant equality of rank and treatment) as forbidding Argentina from making payments on its restructured debt if at the same time it does not pay the bondholders who did not accept the terms of the agreement. Successive appeals led to a U.S. Supreme Court decision that, last June, denied cert on a petition filed by the Republic of Argentina.

The damage from such novel interpretation of the clause is of incalculable scope, as it creates a precedent that will endanger current and future agreements States reach with creditors in debt restructuring negotiations. Having the guaranteed chance to sue for a 100 per cent of their credit, it is difficult to see how any creditor would accept less, thus making the path to debt restructurings even more fraught with difficulties than it already is.

The UN resolution adopted this month, which had been tabled by the developing countries’ negotiating bloc at the UN (the Group of 77) only in August, was passed with 124 votes in favor, 41 abstentions and 11 against. The General Assembly year after year issues resolutions on debt that generally leave the status quo unchanged. What makes this one remarkable by historical standards is that it takes the bold step of initiating negotiations on a multilateral legal instrument and sets a deadline of end of 2014 for the definition of modalities for negotiation of such a text.

Momentum for action of this sort has, no doubt, grown after the US Supreme Court’s recent ruling refusing to examine the ruling on the NML case. The fact that there would be new momentum around statutory solutions for debt restructuring was a predictable outcome should the US Supreme Court decide the way it did and, in fact, in a joint piece co-authored with Jose Antonio Ocampo this author did predict it. In a piece appeared on the Financial Times on July 9, 2013, we argued that “a ruling in favour of the holdouts will make voluntary debt restructurings almost impossible in the future, thus putting further pressure to establish a statutory framework for sovereign debt restructuring mechanisms, and making the position of those who are against it, such as the US, harder to justify.” What we just did not imagine was that the pressure would mount so fast.

Civil society groups have repeatedly called for the establishment of an international sovereign debt restructuring mechanism as a key institution missing in the global financial architecture. This gap was recognized as such by former Deputy Managing Director of the IMF, Ms. Anne Krueger in just as stark words in a 2002 speech. Domestic legal frameworks almost everywhere foresee the need for bankruptcy as an institution to ensure that, when a company goes insolvent, there is fair burden-sharing among creditors, that creditors are subject to the discipline of taking losses for their own wrong decisions, and the debtor can re-establish viability to generate income for repaying the creditors. There is no such multilaterally-agreed institution for sovereign debtors, thereby enabling rampant moral hazard on the side of creditors and making sovereign debt crises longer and more costly (for all actors, including creditors as a collective).

The human rights imperative behind the need to take action on this issue was again in evidence before the resolution as more than 100 human rights organizations defined it as a problem one of “the most heated debates in the international community about how to balance the interests of creditors and debtors in ways that ensure States can respect their obligations in the promotion and protection of rights.” In a letter before the vote, these groups called upon governments to ensure the human rights perspective would be fully incorporated into the resolution’s text and in the deliberations.

The human rights consequences of the decision were also in display as the Group of 77 took the unprecedented step of requiring, before the vote, an expert opinion from the Independent Expert on Foreign Debt and Human Rights. In his opinion, this expert offered a recap of the international human rights law principles that justified filling the global legal void on sovereign debt restructuring and said that human rights obligations and in particular minimum essential levels of satisfaction of each economic, social and cultural right should be respected, including in the context of debt restructuring. He commented that vulture funds’ disruptive litigation is only one – but probably the most prominent – evidence of the consequences of the global legal void on debt restructurings. “If sovereign debtors are forced to grant a few private and highly speculative lenders preferential treatment at the expense of creditors that made sacrifices to let the country recover, the duty to perform a serious credit risk assessment will be the first victim,” he added.

Neither the procedural nor the substantive reasons offered by countries that voted against the resolution stand proper scrutiny. Some argued that the process had been rushed and there was not  proper time to consider the resolution. But all countries had already agreed to consider sovereign debt restructuring mechanisms at the International Conference on Financing for Development, back in 2002. We may indulge with the idea that twelve years do not make the resolution too late, but definitely not with the idea that it was a “rushed” measure.

More surprising was the United States’ delegation substantive objection that a sovereign debt restructuring mechanism would introduce uncertainty in financial markets. Precisely the opposite flows from an IMF report last year that expressed that the recent US court ruling “by offering holdouts a mechanism to extract recovery outside a voluntary debt exchange, . . .  would increase the risk that holdouts will multiply and creditors who are otherwise inclined to agree to a restructuring may be less likely to do so due to inter-creditor equity concerns.”

Another objection wielded against the resolution was a familiar one: that a contractual approach could offer the same results, so why bother with a legal framework? The contractual approach essentially entails including in sovereign debt contracts language that, in a situation where restructuring deals are reached with a majority of creditors, force the minority to accept similar terms. In the days leading up to the debt resolution vote, the International Creditors Markets Association, an association of bankers, investors and brokers came up with yet a new version of this approach publishing model clauses that could be included in bonds.

But in a recent article analyzing efforts to encourage contractual solutions to avoid disruptive holdout creditor behaviour that date back to 1820, US professor Mark Weidemaier finds reason to be quite skeptical with the claim that by fiddling with sovereign contract terms one can have significant effect on the problems associated with sovereign debt crises. He concludes that “there is a long history of government and official sector efforts to prompt contract change. For the most part, this is a history of failure.”

It seems a look at history is overdue, and we should thank the United Nations for having decided, as a collective body, not to be on the wrong side of it.