Part of the problem is that when the idea of SDRM
was first introduced, at the end of 2001, it gave far too much
power to the IMF; since then, Fund officials have generally
attributed the adverse private-sector reaction to SDRM to a
failure to understand the changes that were made to it in
April.
But the private sector does understand SDRM, as do borrowers. In a
nutshell, it's a bankruptcy regime for sovereign issuers, where all
the major decisions have to be taken by a supermajority of
creditors.
SDRM is supported, as one senior IMF official says, by "people who
are making sure that in future crises the prospect of large-scale
financial assistance is off the table". That's code for the US
Treasury, which opposes an IMF quota increase on the grounds that
the Fund having less money is basically healthy and a good
idea.
No matter how good an idea SDRM is on its merits, insofar as it
replaces direct IMF aid packages it's a bad idea for borrowers. The
IMF is working hard to persuade borrowers to see the two things as
separate issues, without success.
Investors see the heavy hand of the IMF pushing them down into
junior creditor status, ensuring that it will always get repaid
first and in full before bondholders and other private-sector
creditors get to fight with the Paris Club over what's left.
Historically, the IMF and other international financial
institutions (IFIs) have had preferred creditor status: they get
repaid first. The rationale for that status is that the IFIs step
in where free markets don't or can't work. Charles Calomiris,
professor of economics at Columbia University, says that there is a
good argument for giving the IMF de jure preferred creditor status
if it is providing liquidity to the market in a crisis. But, he
says, that isn't happening at the moment: "If you had a real
liquidity crisis, you would need a vast amount of money to be
pumped in there. Under the present situation, I can see an argument
for making the IMF junior."
The fact is that preferred creditor status has, until now, had no
legal standing in either national or international legislation.
It's simply a convention, which is granted, ultimately, by the
borrower countries. But it's a vitally important convention for the
IFIs, which could find themselves in a major cash crisis if
emerging-market nations started defaulting on them.
"The IMF is trying to subordinate as many other creditors as
possible," says one fund manager. "The IMF is solving not its own
problems, but our problems, which we haven't asked it to solve. The
prospect of an Argentine default, and then Brazil, is making its
hair stand on end."
It's unfortunate for the IMF, as the one institution with the
clout to be able to push through a workable version of SDRM, that
it also has such a blatant conflict of interest as a creditor whose
own loans would be excluded from the mechanism.
And it's not just the IMF's loans which would be excluded, either:
the World Bank would also have preferred creditor status, even when
it had lent at market rates.
Private creditors are also concerned about the Paris Club, which
will almost certainly be excluded from the SDRM on the grounds that
it has proved itself able to negotiate its own restructurings very
well, and that there's no reason to complicate those largely
informal negotiations by incorporating them into the formal legal
structure of SDRM.
The Paris Club will get its way in negotiating the structure of
SDRM, simply because its members account for roughly half of the
voting weight in the IMF, and they want to stay out.
Paris Club negotiations normally start and finish within a few
days; if they were incorporated into SDRM they could take much
longer.
Under the present proposals, every creditor group would have a
veto over every other creditor group's restructuring, and the Paris
Club has no reason to want to complicate its already-fragile
negotiations by giving bondholders and others the ability to
scupper them.
The Paris Club also uses the "if it ain't broke, don't fix it"
argument. "The SDRM is designed as a way to settle the lack of
creditor organization and the risk of disruptive litigation," says
Ambroise Fayolle, vice chair of the Paris Club. "The Paris Club
sentiment is that it has already dealt with this issue and that a
more formal mechanism is not necessary to make official creditors'
negotiations work."
The problem with that argument is that it works only too well,
tweaked a little, in other contexts. Banks, for instance, can say
that the London Club already works well and doesn't need fixing;
even bondholders can point to successful bond restructurings and
ask why SDRM needs to be layered on top.
But bank loans and bond issues are a non-negotiable part of SDRM.
The problem, as those creditors see it, is that they are rapidly
becoming the only part of SDRM. In the absence of IFIs and the
Paris Club, there seems little hope for negotiating questions of
inter-creditor equity between these classes; indeed, SDRM more or
less has the IFIs' preferred-creditor status built in.
For all its own problems, however, SDRM does solve, in a
relatively elegant manner, a lot of architecture problems that are
otherwise difficult if not impossible to address. It aggregates
creditors, it prevents disruptive litigation, it provides a
recognized international forum for dispute resolution, and it
unifies the way in which bonds are restructured regardless of the
nationality of the issuer, the borrower, or the jurisdiction in
which the bonds were issued.
It also has an attractive combination of power and flexibility
when compared with collective action clauses. It has the force of
international treaty law but it doesn't need to spell out ex ante
exactly what's going to happen in the event of default. Indeed,
Anne Krueger makes a point of noting that she expects many, if not
most, restructurings to occur "in the shadow" of the SDRM, rather
than in it.
In that, she might be a little optimistic. Although it's true that
corporate restructurings in the US regularly take place outside a
bankruptcy court, that's only because there have been so many
bankruptcies that the court proceedings have become completely
predictable. With every sovereign debt crisis different, however,
and sovereign defaults much less frequent, on an absolute basis,
than corporate defaults, there will probably never be a situation
where creditors and debtors don't need to go to the SDRM because
they know exactly what will happen when they get there.
SDRM has other shortcomings, too. As Brazilian finance minister
Pedro Malan notes: "The delay and reluctance of sovereigns to
recognize a given debt position as unsustainable are caused by the
uncertainties in determining when debt becomes unsustainable, and
by the very high economic dislocation and reputational costs
associated with debt restructurings, and not by the lack of a
procedural mechanism to secure collective action on the part of the
creditors." In other words, the existence of SDRM would probably
not help countries with an unsustainable debt burden to default at
the optimum time for themselves and their creditors.
Malan would also like to see SDRM introduced through a brand-new
treaty, rather than by an attempt to amend the Fund's Articles of
Agreement. "The issue falls outside the Fund's purposes, and was
never envisaged by members when they originally subscribed to the
Articles," he says, although he neglects to mention that the
amendment route is much easier than attempting to build whole new
international institutions.
It's not as though the Articles of Agreement are easy to amend.
The last time it happened was in 1976. That was to ratify the
Jamaica agreement, which New York University law professor Andreas
Lowenfeld calls "completely uncontroversial", to take the IMF off
the gold standard and allow floating currencies. That amendment
took 32 months, from January 1976 to September 1978, before it
actually got done.
Lowenfeld also warns that "it's not clear that the new treaty
obligation would stand up in US court with respect to bonds issued
before the new treaty went into effect,"although it would certainly
make any litigation strategy much higher-risk.
And even getting as far as attempting ratification could be
extremely difficult, considering the steadfast opposition which
SDRM has received. In late September, representatives of the
private sector, senior officials from the G7 and senior officials
from some key emerging markets had an unprecedented meeting at the
US Treasury.
In a speech given in the following month in New York, Treasury
undersecretary for international affairs John Taylor said that "the
views expressed by these three groups are important for determining
how to proceed in the future. All the G7 officials reiterated their
governments' support for incorporating collective action clauses
now and continuing to work on a more specific proposal for the
SDRM. The private sector supported the collective action clauses,
but strongly rejected the SDRM. Many of the emerging market
countries expressed support for the collective action clauses; many
also expressed disapproval of the SDRM."
The clear implication is that SDRM needs more investor and
borrower support than it currently has. At the IMF annual meetings
in September, the IMF's International Monetary and Financial
Committee (IMFC) instructed the Fund "to develop, for consideration
at its next meeting, a concrete proposal for a statutory sovereign
debt restructuring mechanism to be considered by the
membership."
The next IMF meeting is in April, and it looks increasingly as
though that's the deadline for the IMF to persuade at least a few
key borrowers and investors that SDRM is a good idea. If the Fund
fails, SDRM could lose momentum and become little more than a
back-up plan for the possibility that CACs turn out, in a few
years' time, to be inadequate. But if it succeeds, and persuades
the IMFC to give it the go-ahead, in that same few years' time the
world could be a place where countries, finally, are able to go
bankrupt just like companies. Then we'll see how many
do.
