Now That Everyone Is on the Standstill Bandwagon ... Where to? Part II

Delivering pandemic-fighting resources through debt relief channels poses at least three overlapping implementation challenges--no bandwidth today, Groundhog Day tomorrow, and inter-creditor equity forever--in addition to the challenge of monitoring the use of proceeds I flagged in Part I. I sketch these three below, alongside three possible solutions -- a model standstill agreement for all kinds of debt, retrofitting contingent standstill terms in all kinds of debt contracts, and a standing sovereign debt coordinating group.

No Bandwidth: A Crisis Containment Problem. Debtors, creditors, and the international policy community have just promised to renegotiate hundreds of debt contracts in dozens of countries with thousands of creditors each. Many borrowing governments with limited human and financial resources in the best of times would be managing a public health crisis while teetering on the edge of default. The unprecedented diversity of creditors and claims, and the mixing of public, private, foreign, and domestic creditors in identical legal claims, compound the administrative challenge and set the 2020 sovereign debt crisis apart from those that came before. The fact that the poorest countries (so far the only ones eligible for a debt standstill) have so little debt in the form of tradable bonds means that their debt documentation is less likely to be standardized or publicly known -- and might present an attractive arbitrage (aka free-riding and asset-stripping) opportunity.  In the absence of sovereign bankruptcy and an automatic stay on creditor enforcement, debtors would need an alternative structure to freeze this mess in place. 

• One way to cut through the clatter would be to offer a model standstill agreement with standard terms to all of the government's creditors, or at least to all its private creditors, regardless of the claim they hold. The terms, which could look something like this recently published ABA model,  would have to be super simple--"I, Creditor, hereby waive my right to receive timely interest payments from Sally Sovereign for the next N months,  and agree to receive them in X installments beginning on date Y"--and could be prepared under the auspices of a trade group, such as the ICMA , EMTA, or the abovementioned IIF, all of which have some experience with sovereign debt contract drafting. Financing from the World Bank's Debt Reduction Facility (DRF) for IDA countries could help develop the model and adapt it for each country.
  • I would prefer to see countries adopt a model agreement wholesale, with customized provisions spelled out in annexes or similar agreed with their creditors, similar to modular derivatives documentation. The modular approach would create a strong gravitational pull to standardize and would make it easier to spot departures from inter-creditor and policy consensus, but would still leave plenty of room for customization.  More-or-less customized annexes could specify how the debtor would account for its use of proceeds (healthcare, not yachts), and/or include consent solicitations for bondholder majorities to amend their bonds, if the sovereign decided to pursue a more ambitious restructuring. 
• Importantly, a standstill agreement without more would not eliminate holdouts or neutralize them. A minimum participation threshold ("this agreement goes into force after Z% of Sally Sovereign's Outstanding Debt have signed on") could help boost creditor participation. The outreach process could also help flush out potential holdouts and guide a subsequent restructuring. Truly neutralizing holdouts would require the sovereign to rely on collective action clauses in bonds or the deterrent effect of pro rata sharing clauses in loan contracts. There is no guarantee that each debtor would have either clause on a meaningful scale.

Groundhog Day: A Crisis Management Problem. One of the most distressing aspects of the current official consensus on standstills is its planned expiration at the end of 2020. No one has seriously suggested that the crisis would be solved by then, nor that governments facing debt pressures and a healthcare shock would gain access to new money on acceptable terms next fall. The expiration date guarantees that the same parties would be back at the same negotiating table on the margins of the next IMF-World Bank-G-20 conclave. One way to make the next n rounds of standstill talks less messy and painful would be to offer all current creditors an option to extend the standstill automatically, provided certain agreed conditions are met. Conditions might include persistently grim healthcare outcomes and outlays, continued collapse in exports and way-below-trend GDP growth, all as verified by an agreed authority.

• The simplest and narrowest way to achieve the next automatic pause would be to include it as an option in the model standstill agreement discussed above. The automatic extension would be clearly time- and circumstance-bound, and would not affect the underlying debt instrument beyond the immediate crisis.
• More ambitiously, a debtor could offer all its current creditors a small cash payment or comparable incentive (structural priority) to incorporate state-contingent features in its outstanding debt. State-contingent debt has received much love from economists and policy makers over the years, including this recent project at the Bank of England, which included a term sheet. Market participants have been less loving, but they might reconsider in light of the pandemic chaos alternative.
  • Bilateral and multilateral official creditors could even consider supplying participation incentives, such as insuring or exempting from future restructuring contingent debt that delivers a threshold dose of relief. Alternatively, the official sector could help finance modest consent fees.
  • As with the standstill agreement, consent solicitations would help sort the creditors and have an information-forcing effect, flushing out potential free-riders. 

Creditor Coordination and Inter-Creditor Equity: A Perennial Problem.  Adnan Mazarei, Sean Hagan, and I have advocated elsewhere for a sovereign debt coordinating group as part of standstill implementation. While broadly similar proposals for information clearing and negotiating platforms have been many times before, the case for such a group is stronger than ever in a world where creditors are diverse and uninclined to cooperate either within or among different cohorts, and where systemic threats are becoming a way of life. Some of the institutions that had intervened forcefully in past crises seem incapable of such action today. Perhaps most notably, the UN Security Council, which had immunized Iraqi oil and gas from creditor attachment after the fall of Saddam Hussein, today is too riven to come up with a robust statement calling COVID-19 a threat to international peace and security.  A U.S. Administration reluctant to invoke the Defense Production Act for fear of impinging on private industry is unlikely to use executive power aggressively to shield scores of poor countries from lawsuits by private creditors. 

To the extent the sovereign debt restructuring regime worked late in the 20th century, it did so because similarly situated creditors generally stuck together, and insisted on restructuring in sequence, so that everyone's concessions hinged on those by others. 

All the stakeholder concessions and new money would add up to something like a Lego house -- not quite brick, but better than straw. The semblance of order was fleeting and many of the outcomes were deeply problematic, but the overall structure made sense in the absence of sovereign bankruptcy or another binding enforcement mechanism. Now the bricks have melted, and no one follows printed instructions anyway.

A coordinating group could fill some of the gap, promoting intra- and inter-group coordination. Today's coordinating group would have to comprise all major stakeholders, certainly including large bilateral creditors like China, a rotating cohort of private creditors, and could include civil society representation. The G-20 could deputize such a group to pronounce on subjects such as good faith negotiating efforts, comparability of debt treatment among creditor cohorts, and information sharing by the debtor and/or the creditors, as appropriate. It would not have the power to adjuicate disputes; however, it would have the authority to convey broad-based international and public-private consensus to a court considering complaints from would-be free riders. Contract remedies are, after all, in the equitable discretion of the court -- that is why you do not want to be called contumacious.

Lastly, a coordinating group could help bring more equity and accountability across borrowing countries, not just across creditor groups. If it proves effective, such a group could become an important platform for institutional innovation and norm diffusion across today's diverse sovereign debt stocks--one that has been proposed in the past, but is yet to be implemented on a substantial scale.

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The COVID-19 pandemic and its economic fallout call for bold action on debt and demand massive new resource mobilization.The pandemic may make the case for sovereign bankruptcy stronger than ever, but it remains unlikely.  If baby steps are all there is,  they should be as replicable, scalable, and generalizable as possible. With luck and foresight, the right baby steps could build a foundation for a more equitable and sustainable sovereign debt management regime ... eventually.