Guest Post: U.N. to negotiate a multilateral legal framework for sovereign debt restructuring

[Yanying Li is a Ph.D researcher on a legal framework for State insolvency at Leiden University, the Netherlands.]

Following Julian’s post of Argentina’s attempt to sue the United States in the International Court of Justice, I write to share with you the latest (exciting) development in the world of sovereign debt restructuring!

On September 9, 2014, the United Nations General Assembly adopted a resolution entitled “Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes” (document A/68/L.57/Rev.1), with 124 votes in favour, 11 votes against (including the United States) and 41 abstentions. The draft resolution was prepared by Bolivia on behalf of the Group of 77 and China. The last two paragraphs of the resolution provide as follows:

5. Decides to elaborate and adopt through a process of intergovernmental negotiations, as a matter of priority during its sixty-ninth session, a multilateral legal framework for sovereign debt restructuring processes with a view, inter alia, to increasing the efficiency, stability and predictability of the international financial system and achieving sustained, inclusive and equitable economic growth and sustainable development, in accordance with national circumstances and priorities;

6. Also decides to define the modalities for the intergovernmental negotiations and the adoption of the text of the multilateral legal framework at the main part of its sixty-ninth session, before the end of 2014.

According to the General Assembly’s press release, the U.S. delegate stressed at the meeting “that she could not support a statutory mechanism for sovereign debt restructuring as such a mechanism was likely to create economic uncertainty.”  Moreover, she expressed the view that “[i]n the past, market-oriented approaches had been preferred and work was ongoing in the International Monetary Fund (IMF) and elsewhere.” In response to that, the Minister for Foreign Affairs of Argentina stated that “[s]overeign debt held development back and the establishment of a better system could improve global economic security.” The Minister continued that “[t]he clear majority agreed it was time to establish a legal framework for restructuring that respected creditors while allowing debtors to emerge from debt safely. The profits currently made by vulture funds were scandalous and were funnelled into campaigning and lobbying to prevent changes to the situation.”

Needless to say, this is a big step forward in terms of the development of international law on sovereign debt restructuring. It reminds us of the IMF’s efforts back in 2001 to establish a treaty-based framework to restructure sovereign debt – the Sovereign Debt Restructuring Mechanism (“SDRM”). The key feature of the SDRM is a majority voting system, which binds all creditors to a restructuring agreement that has been accepted by a qualified majority. Other elements of the SDRM include stay on enforcement, priority financing and dispute resolution forum. It is worth noting that the SDRM does not directly address inter-creditor concerns as it would identify the range of claims that could be potentially restructured under the mechanism, but leave to the debtor to decide which subset of eligible claims would need to be restructured in a particular case. The SDRM proposal was eventually shelved due to a lack of support from the U.S. The U.S. was able to kill the SDRM because (1) the adoption of the SDRM required an amendment of the IMF’s Articles of Agreement, which needs the approval of 3/5 of member States, holding 85 percent of the total voting power (Articles of Agreement of the International Monetary Fund, as amended, art. XXVIII (a)); and (2) the United States by itself holds 16.75 percent of the total voting power and thus could veto any attempt to amend the Articles of Agreement.

Then, will this time be different? Will the lack of support from the U.S. for the September 9 resolution make it a useless document? In my view, it is still too early to gauge. On the one hand, the resolution was supported by a large number of countries (i.e. 124). On the other hand, while the resolution provides that the modalities for the intergovernmental negotiations and the adoption of the text of the multilateral legal framework will be addressed at the main part of the General Assembly’s 69th session, this item is still not yet included in the provision agenda for this session (A/69/100). Plus, there is no draft text of the multilateral legal framework, although it is quite clear that what Argentina wants is something similar to the SDRM-type majority voting system that could bind holdout creditors to a restructuring agreement that has been accepted by a qualified majority.

Another interesting issue is whether the UN, rather than the IMF, is the appropriate forum to negotiate a multilateral legal framework for sovereign debt restructuring. As noted by the U.S. delegate, work on this topic was already ongoing at the IMF. In 2003, despite of the failure of the SDRM proposal, the idea of a majority voting system survived. Collective Action Clauses (“CACs”), a contractual approach to implementing a majority voting system, gained broad support from market participants and sovereign debtors. The charm of CACs is that they could enable a qualified majority of bondholders to bind all holders of the same bond series to an amendment of the contract terms, including the maturity date as well as the amount of interest and principal. However, unlike the SDRM that contemplated aggregated voting across all debt instruments, the voting under CACs is conducted on a series by series basis. In April 2013, the IMF revisited sovereign debt restructuring and discussed potential reform ideas. Among other things, the IMF Board of Directors agreed on the need to strengthen the existing contractual framework to make it more effective in overcoming collective action problems posed by holdout creditors. In this context, it was suggested by the IMF staff that a more robust form of aggregation clause could be included in future CACs to enable voting across different series. The Board of Directors will examine this suggestion in early October.

The ongoing work at the IMF, in my view, does not automatically make the UN an inappropriate forum to negotiate a multilateral convention on sovereign debt restructuring due to the different nature of their current work. Importantly, the IMF’s revisit does not intend to revive the SDRM. It will simply strengthen the existing contractual framework in preventing holdouts, which is much less ambitious than negotiating a multilateral convention at the UN. Moreover, given that each country shall have one vote in the UN General Assembly (Charter of the United Nations, Article 18) and the voting power at the IMF is largely based on a country’s GDP, the view of the Group of 77 will certainly carry more weight in the UN. On top of that, from the perspective of potential conflict of interest, the UN is not involved in sovereign lending and borrowing practice but the IMF is a lender itself.