By Brian Caplen French civil servants use old-fashioned methods to persuade Paris Club creditors and debtors to reach agreement: duress and subterfuge. Holed up in the vast post-modernist complex that houses the French treasury, participants are kept working – or waiting – throughout the day and night, with little sleep or food, until one side cracks.
The creditors sit in a windowless conference hall while the debtors are crammed into a tiny meeting room downstairs. OVers and counter-oVers are relayed between the parties by treasury officials who, to quote one delegate, “control the information Flow to maximum advantage”. Their aim is to get deals done rapidly, on terms agreeable to the creditors and that accord with French or G7 foreign policy.
This is easy to achieve since Paris Club rules are not written down but are kept inside the heads of the treasury officials. A shrewd negotiator will quote the precedent of, say, Guinea in 1995 on Naples terms, to push an agreement forward, knowing that few if any delegates will have the expertise to challenge it. Even the order in which creditors are called on to speak may have been calculated by the chair to encourage a certain outcome.
Many debtors are totally fazed by the experience, which even one of the creditors describes as “humiliating and colonial”.
While the G7 countries are treated to a grand lunch, the debtors are reduced to pleading with an official to order them pizza. At the same time some debtors are so badly prepared that they are beaten almost before they start.
Their Figures don’t add up and usually don’t agree with those of the creditors. Many don’t understand the principle of compound interest. Their best MBAs are working on the national budget, not starving at the Paris Club. Only the Russians can survive in these conditions because they are organized and have the stamina to outlast everyone else.
“It always struck me that there must be a better way of doing it,” says one former UK treasury official who used to attend Paris Club meetings. “When it gets to 3am, your mind is fuzzy and you just want to sleep, can you really be producing the best results? This approach seems hopelessly out of date.”
“Paris Club meetings are surreal,” says another participant. “It’s like being in a production of the Wizard of Oz. You lose all track of time.”
Changes are being urged on the Paris Club. It is under the spotlight for lack of transparency, inflexibility and a hard-line view that comparable treatment between distressed private and public sector debts only runs one way: if the Paris Club cuts a deal the private sector has to follow suit but not vice-versa.
Now there are moves to organize sovereign defaults in much the same way as corporate ones, with all the creditors – governments, banks, bondholders, multilaterals – being involved. The influential Council on Foreign Relations in the US has been working on proposals to this effect. But no-one expects rapid reform. The Paris Club has yet to establish a website and its press releases have been described as “muddled and meaningless”. One tried and tested club technique is to obfuscate the results of a negotiation so that all parties can declare victory. Giving up such powers by adopting transparency would clearly be unattractive to the French treasury.
An IMF precedent
Yet the pressure is on, especially since the IMF – also criticized for secrecy and backroom dealing – has made a lot of progress over the past three or four years in opening up.
Attacks on the Paris Club are coming not only from predictable quarters, such as hedge fund managers who have taken a haircut on their bonds, but from senior bankers. Veteran debt negotiator Bill Rhodes, vice-chairman of Citigroup, is usually diplomatic and circumspect about the players in international Finance. After all he may need to call them up next time he is involved in a debt workout. But he feels so strongly about what is happening that he was adamant his conversation with Euromoney should be on the record.
“There needs to be a proper working relationship between the private sector and the Paris Club,” Rhodes says. “They have to sit down and hear our opinions. The official sector and the G7 are always talking about transparency. But what they often mean is transparency for others, for developing countries and the private sector. Why don’t we have more transparency in the official sector? There needs to be more transparency [in the Paris Club], more Flexibility and more dialogue with the private sector.”
Lex Rieffel, who was formerly a debt relief expert with the US Treasury, and now works for the Institute of International Finance in Washington, says: “The IIF’s concern is that the Paris Club is part of the problem rather than part of the solution. It has not taken the same kinds of steps forward to be transparent as has the IMF.”
Rieffel wrote two papers on the Paris Club in the 1980s and in one, published by Princeton University and entitled The role of the Paris Club in managing debt problems, he states: “The world of economics and Finance is full of mysteries. While many are genuine and arise from the complexity of human behavior, some appear artificially contrived by groups of players who Find it convenient or advantageous to camouflage their activities from others. The Paris Club is a mystery of the second category…”
The mystery began in 1956 when the Paris Club First convened to consider how to treat Argentina’s external debt. Since it was never a legal body and always under the auspices of the French treasury, it was prevented from developing into a huge sprawling bureaucracy.
This is clearly to its advantage and enables rapid deal completion. The downside is that so much power rests with a few officials. There is a small permanent secretariat and the chairman is always the head of the treasury or the head of international affairs at the treasury.
The names of past senior officials at the Paris Club reads like a who’s who of French Finance: Michel Camdessus who went on to be president of the IMF; Jean-Claude Trichet now France’s central bank governor; Jacques de Larosière, also an IMF president and a past president of the EBRD; Christian Noyer, now an executive director at the ECB; Francis Mayer, now a vice-president at the European Investment Bank; and Jean Lemierre, the current president of the EBRD. The present incumbent is Jean-Pierre Jouyet, a former deputy head of the prime minister’s office.
Debtors say they can tell how important they are by who is chairing the meeting (not always the club chairman) when their requests for a rescheduling are heard. Meetings on Russia or Pakistan will probably be chaired by the top guy. He will have to explain the outcome to the French Finance minister and being able to say he kept everybody there until 4am, to drive through a hard bargain, bodes well for his career. “I always had the feeling that some of the waiting was so that the chairman could impress his minister. For him it didn’t matter because he could just go off to another part of the building and do his normal treasury work,” recalls a creditor.
But a sub-Saharan African state, especially a non-francophone one that does not matter to the politicians, could be chaired by someone less senior. Given the lack of a manual or a rulebook by which treasury officials can be challenged, it’s also the case that the outcome of negotiations depends considerably on the personality of the treasury official in charge.
One of the most respected officials is Philippe de Fontaine Vive, who recently left his role as vice-president to take up a position privatizing French state-owned companies. De Fontaine Vive is noted as a tough and eYcient negotiator in the typical Paris Club style.
“He uses First principles to form questions to which the answer can only be ‘yes’,” says a creditor delegate. De Fontaine Vive handled the meeting when Indonesia rescheduled last April.
Another comment on de Fontaine Vive’s style, by a former delegate, provides clues as to what are regarded by critics as the shortcomings of some other treasury officials. “He is fairly unusual among his colleagues in that he would not allow himself to be provoked by the obstinate nature of other members of the Paris Club into anger or positions that stop the process. Other people allow themselves to become frustrated and annoyed and this slows the process. When he thought it was to his strategic advantage to get angry he would do so but only when everyone in the group thought that the person receiving the rebuV deserved it. Because this is a system without formal rules, success depends very much on how adept the negotiator is.”
But for all his considerable talents and intellectual rigour, de Fontaine Vive is unbending in his position that the fundamental principles of the club are not going to change. He met Euromoney in room 5182D of the Bâtiment Colbert section of the French treasury on a sticky day in mid-August when most Parisians had left for les vacances. He was joined by his successor, Bruno Bezard, and Jérôme Walter of the secretariat.
One-way comparability
De Fontaine Vive is young, urbane and modern in demeanour but during the interview he quickly retreats to the traditional view that the state’s position is non-negotiable. He says that since September 1998 the Paris Club has started having informal discussions with the private sector but he does not envisage any far-reaching changes in the debt workout process involving, for example, more formal communications between the private and public sectors. And, most controversially, he says that comparability of treatment will continue to work in one direction only.
“The fact that the private sector has understood that it [comparable treatment] works only one way shows that the learning process [dialogue with the private sector] has been useful,” he says. He says that in cases of sovereign indebtedness, multilaterals such as the IMF are senior to all participants because they are lenders of last resort.
Neither the Paris Club nor the private sector challenges that, he says. So why should the private sector challenge the view that the club is also senior to it?
The official creditors provide new money and they stick with a debtor over the long term whereas the private sector has the option to sell and quit the market, he says. “If we intervene and provide public goods that benefit the Financial community we want to be sure there is burden sharing. Comparable treatment runs only one way and that doesn’t change,” he says.
Some observers note that the Paris Club used to have a better dialogue with the private sector. Under Trichet, for example, bankers were accustomed to receiving calls from the chairman explaining what was going on. De Fontaine Vive confirms that this is no longer the norm. “Don’t have the idea that the chairman of the Paris Club is supposed to call upon the chairman of this bank or that pension fund or a given representative of the bondholder community [to consult]. This is not the responsibility of the Paris Club.”
De Fontaine Vive dismisses the idea that delegates do not get enough to eat at meetings but he has warned Bezard to be prepared for sleepless nights. He confirms that there is no manual of Paris Club rules but says that many club negotiators have far more experience than him and could easily challenge him if there were doubts about a principle.
“The Paris Club is not an institution, it’s a non-institution,” he says. “There is no charter and no manual. You have a collective of good men, representatives of their countries, and they are used to working together, to get the best results for both debtor and creditor countries.”
He says that everyone has access to the same information and that participants have sufficient confidence in the chair not to ask for a supporting paper when a precedent is quoted. They have faith in the system, he says, and no-one has ever been so dissatisfied with the work of the French treasury as to suggest moving the system elsewhere.
Even though the Paris Club does not have a manual, it does have a broad set of principles it works from. They are as follows.
l Conditionality: a debtor must have an IMF programme before the Paris Club will agree to a meeting.
l Case by case: decisions are taken on a case-by-case basis to adjust remedies to the country in question.
l Consensus: no decision can be reached without a consensus among creditors.
l Solidarity: creditors do not try to seek a more favourable agreement than those reached by other countries.
l Comparability of treatment: after negotiating a deal the Paris Club commits itself to seeking the same terms from non-Paris Club creditors.
With all the furore about burden-sharing, it would be easy to conclude that comparability of treatment was a new concept. But its inclusion in this list of principles indicates that it’s not. The club has always followed this line of argument and has always believed comparability to be a one way street.
During the debt crisis of the 1970s and 1980s, when the Paris Club really grew in stature, the commercial banks took a 40% write off on their loans when they were transformed into Brady bonds. But the club did not do likewise.
It followed its standard approach of granting grace periods and rescheduling interest payments while studiously avoiding reducing the stock of debt. There were successive reschedulings with such countries as Brazil, Argentina and Mexico yet never once was there a write-down of the principal. In fact only in two cases in its history has the club ever reduced the debt stock of a middle-income country, and this was for political rather than economic reasons. Driven by the needs of US foreign policy, Egypt had its debts cut by 50% as a reward for its government’s support during the Gulf War. Poland got similar treatment in recognition that it was emerging from communism.
What has changed, however, is the economic environment in which the Paris Club is imposing comparable treatment. Previously most private-sector Flows consisted of bank loans and the banks were prepared to accept “one way comparability” because they also benefited from the official Flows. Most club debt relates to trade Flows guaranteed by export credit agencies. When the debts went bad this private-sector business became the responsibility of government departments.
Since the credit was channelled through banks they got to do this business without the worry of having to collect if things went wrong.
In this period official Flows were also much more significant in the total composition of capital Flows to emerging markets. Now private-sector Flows account for more than 80% of the total and bonds have taken over from bank debt as the major source of Financing, at least for middle-income countries with access to the markets. “There is not a single country in the world that has an interesting future based on projected official Flows,” says Rieffel. “Private capital has to be there.”
When the Paris Club engaged in one-way comparability in the 1970s and 1980s, bond holders were excluded as these Flows were insignificant. The idea grew up that sovereign bonds were somehow sacrosanct and immune from restructuring. Bondholders received a nasty shock in late 1999 when the club sought a restructuring of Pakistan’s three Eurobonds as a condition for rescheduling official debt.
The change in approach followed the Russian crisis when the government continued servicing Eurobonds while defaulting on other debt. Soon Ecuador, Romania and Ukraine were earmarked by the IMF and the Paris Club as suitable candidates for the same kind of treatment as Pakistan.
Bondholders are not amused. They argue that export credit guarantees are granted for policy reasons (supporting national industries such as defence, aerospace and power and to assist recipients for strategic reasons) and are not comparable to funds raised in the markets. They object to comparability only running one way and they say that with official Flows in decline anything that interferes with private Flows will have a negative impact on capital availability for developing economies.
Philip Poole, chief economist for emerging Europe, the Mediterranean and Africa, with ING Barings, says: “Commercial lenders lend on commercial terms and governments lend on political terms. Theirs represents foreign policy. Why should commercial lenders be tied into burden-sharing on this basis?
“What makes things worse is that burden-sharing disappears when it doesn’t suit the official sector. When the private sector has taken a hit the public sector doesn’t feel obliged to write down its own debt.”
Richard Gitlin, a partner in international law Firm Bingham Dana, who is working on establishing a new sovereign workout structure, says: “At one time bond investors thought their holdings would not be involved in a restructuring. Once you move from a situation in which bondholders automatically get paid to one in which they suffer, there has to be a fair procedure. Currently the process is haphazard and arbitrary. If this continues investors will lose faith in the asset class.”
The process has become a good deal more haphazard following the Russian and Ecuadorean crises when the private sector agreed to terms in the London Club, the forum for private-sector restructurings, prior to the Paris Club. The normal course of events is for the IMF to agree a programme, paving the way for the Paris Club to do a deal, followed by the private sector. This reversal of order is further evidence of new economic conditions, with private Flows becoming more significant than official Flows, and has fuelled calls from the private sector for the Paris Club to oVer comparable treatment.
In Ecuador’s case private investors last month agreed to a 40% debt reduction in an exchange of defaulted Brady bonds – Ecuador is the First country to default on Bradys – an instrument that arose out of a 40% hit taken previously by commercial bank lenders.
“This is a 40% hit on paper that has already taken a 45% hit. All the Paris Club has done to date is to roll over capital and interest but with no principal relief,” says Rhodes. “The Paris Club doesn’t live up to its own insistence on comparability.”
The Ecuador case illustrates another aspect of Paris Club negotiations – the poor state of readiness in which some countries approach it for relief. Club insiders say that when Ecuador attended in May the Figures were incomplete and didn’t match those of the creditors. Finally, the then Finance minister, Jorge Guzman, declared that he had a meeting to attend in Quito and saw little point in remaining. He resigned shortly afterwards in an argument over economic subsidies so he may have had other things on his mind.
“Coming out with Figures that don’t match those of the creditors can be part of the gamesmanship of negotiating a deal or it can just be sloppiness,” says a Paris Club creditor. “The solution would be to have the IMF verify the Figure as part of its programme.”
Ecuador is among only a few countries that have left the club without a deal. Others are Bosnia Herzegovina, which suffered from having three Finance ministers who didn’t agree on anything, and Macedonia, which would not accept the form in which its name appeared on documentation.
Ecuador’s strategy, according to the head of the country’s debt renegotation commission, Jorge Gallardo, is to return to the Paris Club this month and ask for Houston terms (a 15-year repayment period with an eight-year grace period). “Then we expect to again go to the Paris Club next April and depending on what happens to other countries, such as Russia, we may be able to ask for debt relief [stock reduction].”
It promises to be an interesting few months ahead because creditor officials are adamant that Ecuador and Russia are not in line for what would be special treatment, if a reduction was given. Paris Club negotiators are guided by their political masters and the indications from this year’s G7 meeting in Japan was that, with the Russian economic situation improved by the oil price, no favours would be forthcoming. With debtors that are uninteresting, politically, creditor civil servants are given a freer hand to agree deal terms.
Gulag-sur-Seine
Given the disparity between the positions of the G7 and the Russian government, Russia’s next visit to the Paris Club is likely to be protracted. Tough negotiations between Russia and the club include those that saw Russia admitted as a creditor country and the session in 1996, with Russia as a debtor, which has become part of club folklore as perhaps the longest and toughest discussion ever and covering the largest amount ever, some $40 billion. It lasted a marathon four days and four nights and delegates crawled out at the end wondering how their experiences compared with life in the Gulag.
The Russian delegation was led by Mikhail Kasyanov now prime minister, who has gained a reputation as one of the shrewdest negotiators ever to come up against the club.
How did he manage this? “Kasyanov was well briefed and knew the details. He was never caught out by not knowing something,” says David Riley, senior director of emerging Europe sovereign ratings with rating agency Fitch who was part of the UK treasury delegation at the 1996 meeting. “His style was very incremental. He would come in with an extreme position and then soften it little by little. Whenever a concession was made on the creditor side he would immediately bank it and he knew exactly when to use the card of having to consult Moscow.”
Kasyanov has become one of the most outspoken critics of the Paris Club. In an article carried by the Financial Times in July, he said: “Comparable treatment should run two ways: it should apply both to the London Club when the Paris Club is the First to agree restructuring terms and to the Paris Club when the London Club goes First. To do otherwise would allow one club to free ride at the expense of the other.
“In the light of the G7’s recent initiative to bail-in the private sector as part of the new global Financial architecture, it is important that official creditors also share the burden and provide comparable treatment when the private sector takes the lead on debt relief.
Only if all creditors participate on comparable terms will the current informal system of sovereign debt workouts remain viable.”
Kasyanov goes further, striking at the heart of the conservative techniques of the Paris Club that inevitably result in debtors returning repeatedly for reschedulings. “It is also clear that a traditional Paris Club Flows rescheduling, in which the payments due during the term of Russia’s IMF programme are capitalized and repaid over time, will only create an ever-increasing stock of debt. This stock will ultimately be the subject of further Paris Club discussion and undermine Russia’s ability to carry out long-term structural reform.”
In a written response to Euromoney’s questions, the Paris Club secretariat says of the Russian situation: “Private and public creditors tend to value their claims in a different way. For all the private creditors that are marked to market, the Russian agreement actually led to an increase of the value of their claims, as unpaid debt was transformed into Eurobonds with better prospects for recovery. In particular, some private creditors purchased their claims with a large discount and made a significant profit from this debt exchange. This is in contrast with Paris Club creditors, who have kept their claims through different restructurings since the beginning.”
A market-based solution
Jerome Booth, of Ashmore Investment Management, an emerging market bond fund manager, argues that the solution is for governments to mark their own loans to market. “What they are trying to do is avoid a write-down in the stock of debt at all costs because that means it has to be shown in the national accounts. If they marked to market their whole approach would change.”
What the Paris Club prefers to do is give grace periods and reschedule interest rather than write down the principal. While club officials argue that this may provide more payments relief in the short term, until a debtor recovers, the unpaid interest is capitalized so the stock of debt ends up being larger than before the rescheduling.
The club’s rescheduling method is that when a debtor in difficulties First approaches, a cut-off date is established and only loans made prior to this can be restructured. The cut-off date is usually made for 18 months before a debtor’s request for help and the aim is to encourage creditors to continue lending knowing these loans will not be restructured.
Once the cut-off date is set, the Paris Club is extremely reluctant to move it even though over time the amount of pre-cut-off debt can dwindle to just a fraction of the total. “The cut off date is the Holy Grail of the Paris Club,” says Riley.
There is also a consolidation period, which usually coincides with the length of an IMF programme, during which loans that fall due will be rescheduled. Any grace period will follow on from the consolidation period and during this time moratorium interest (interest on rescheduled payments) still has to be paid.
This method of working is under attack even from within the governments of the creditor countries. Says a senior UK government official, who does not wish to be named: “One defining characteristic of the Paris Club is its lack of transparency. It’s very difficult to understand completely what they are doing.
We would feel happier with a better-defined and better-understood set of rules as well as a clearly articulated framework on how the public and private sectors can relate to each other in a more co-ordinated fashion. At the moment there is a kind of dance and no certainty about who will go First, the private or the public sector.”
This source goes even further, criticizing the whole paraphernalia of cut-off dates and Flows rescheduling. “You should be adjusting the stock level to put a country’s debt levels on a sustainable footing. If that’s the objective, having a cut-off date and a consolidation period is not the way to go about it. It’s not difficult to Find an alternative method to deal with restructuring and it would also help with achieving some sort of comparability with the private sector.”
Another creditor describes what he sees as the futility of successive reschedulings that don’t involve a write-down. “In some cases we are merely pretending that we are maintaining the net present value of our claims. There comes a point with debtors when it’s necessary to be realistic about what you are likely to get back.”
According to an IMF paper, between 1976 and 1988 the Paris Club agreed 81 concessional Flow reschedulings with 27 of the countries now identified as highly indebted poor countries (HIPCs). “These non-concessional Flow reschedulings allowed for payments equivalent to about $23 billion to be delayed into the future. The debt service paid by HIPCs nonetheless increased from about 17% of exports on average in 1980 to a peak of 30% of exports on average in 1986 … while this approach provided substantial cash Flow relief … it also helped to steadily increase the debt stocks outstanding,” writes Christina Daseking and Robert Powell in a paper entitled From Toronto terms to the HIPC initiative: A brief history of debt relief for low-income countries, published in October 1999.
Under pressure from the G7, the HIPC initiative and such pressure groups as Jubilee 2000, the Paris Club has begun writing down the debts of lower-income countries but there are big differences between the creditors as to how generous they should be. At one end of the scale are the US, the UK and Canada which are keen on debt relief, particularly if it is linked to strategic aims. The US always sends a member of the state department to meetings as well as a member of the treasury. At the other extreme are the small countries such as the Netherlands and Austria with few strategic aims. They regard the process purely as one of debt collection and want every guilder and schilling back. In between are the Germans, who have softened their stance since the social democrats came to power in 1998, and countries such as France and Japan that resist write downs because they are forbidden from making any new loans to debtors that don’t pay back in full.
Nigeria doesn’t add up
The next interesting debate for them is going to be Nigeria. Although US treasury secretary Larry Summers has hinted that a two-thirds reduction might be appropriate (Naples terms), hardliners such as the Netherlands, Italy and France believe Nigeria can and should repay in full.
There is going to be a huge argument about the numbers even before the meeting starts. Nigeria estimates that its Paris Club debt is $28.5 billion of which $18.5 billion is arrears, the club has put it at $34.6 billion, a huge $6.6 billion difference. A former UK treasury official says that the Nigerian government would occasionally send in a cheque with no covering letter and no mention of what it related to, which may explain why there is a dispute about the numbers.
As things stand the private sector must fear the worst. If burden sharing were imposed it could be another case of Bradys taking a second hit – this time of 66%. Now, more than ever, is the time for the Paris Club to start a serious dialogue with the private sector.
