On April 17, legal practitioners, bankers, scholars, and students met at the Federal Reserve Bank of San Francisco to discuss recent developments in sovereign debt restructuring. Sovereign debt restructurings date to at least 300 B.C. and are a practical fact of life in today’s global economy. Recent developments in the realm of sovereign debt restructurings include Greece’s recent restructuring, the Second Circuit’s potentially destabilizing decision in NML Capital v. Argentina, and the seemingly perpetual Eurozone debt crisis.
Professor Christoph Paulus, Director of the Institute for Interdisciplinary Restructuring (Berlin) and graduate of Berkeley School of Law (LLM ’84), presented his framework for creating a Eurozone sovereign debt restructuring mechanism (SDRM). The IMF proposed an international SDRM in the early 2000s, but the plan lost out to market driven approaches. Market driven approaches to sovereign debt restructuring include the use of Collective Action Clauses (CACs) in debt contracts, which allow a qualified majority of bondholders to change the terms of the contracts to effectuate a restructuring.
Professor Paulus’s proposed Europe-centered SDRM envisions a “resolvency” proceeding for sovereigns – a more optimistic and palatable vision of restructuring than an “insolvency” proceeding. The proposal includes three key requirements: (1) the inclusion of a resolvency clause in bond contracts that would trigger resolvency proceedings under certain circumstances; (2) the creation of a resolvency court overseen by a president who would in turn select 30–40 elder statespersons to serve as judges in potential resolvency proceedings, and; (3) the development of the resolvency court rules of procedure. The envisioned resolvency process is roughly comparable to insolvency proceedings under most country’s corporate laws and would be intended to promote orderly negotiations between sovereigns and bondholders.
Following Professor Paulus’s presentation, Professor Barry Eichengreen facilitated a lively discussion detailing the limitations and virtues of an institutional approach as compared to market driven approaches, including CACs. Professor Eichengreen described the moral hazard argument against the creation of an SDRM – that such an institution could make it too easy for sovereigns to write down their debt. Nonetheless, Professor Eichengreen pointed out that the moral hazard argument now cuts the other way out of concerns that sovereigns borrow too much, and the market for sovereign debt requires greater discipline. The group also considered Contingent Convertibles (CoCos), an additional market driven approach, as a means to facilitate smooth sovereign debt restructurings. CoCos would convert sovereign debt to equity on the occurrence of certain measurable conditions, such as sustaining a particular GDP.
The ideas and issues raised at the Federal Reserve Bank provided a useful framework for understanding the potential of a Europe-centered SDRM to facilitate sovereign debt restructurings in the future. Limitations and questions remain. There are hurdles to applying resolvency clauses in non-European jurisdictions. Certification is required for ensuring the legitimacy of the elder statespersons who would serve as judges. Methodological questions remain about calculating accurately the effect of an SDRM on liquidity in the bond market, and an account of the insufficiency of market-based solutions (especially CACs) to shore up the argument that an SDRM is in fact needed. Indeed, these ideas are still being developed and stakeholders are not in consensus about the best way forward.