Debt Restructuring
Debt restructuring is the reorganisation of the terms of a debt obligation, undertaken when a borrower is unable or unwilling to meet the original terms. Restructuring may involve a reduction in principal, a reduction in interest, an extension of maturity, or a combination of these measures.
Forms
Restructuring can take several forms. In a rescheduling, the maturity of the debt is extended and payments are spread over a longer period. In a refinancing, the existing debt is replaced by new debt on different terms. In a haircut, the principal or the interest is reduced.
Restructuring may be voluntary or involuntary. In a voluntary restructuring, creditors agree to the new terms, often because they judge that the alternative is worse. In an involuntary restructuring, the terms are imposed, or creditors are compelled to participate through legal or collective mechanisms.
Sovereign Restructuring
Sovereign debt restructuring involves the debt of a government, and it raises distinctive issues. Sovereigns cannot be liquidated, and their assets are generally immune from seizure, so creditors have limited legal remedies. Restructuring therefore depends on negotiation and on the willingness of creditors to participate.
Sovereign restructuring often involves the coordination of many creditors, including banks, bondholders, and official lenders. The diversity of creditors can complicate negotiation, since different creditors have different interests and different legal positions. Collective action clauses, which allow a supermajority of bondholders to bind the rest, are designed to facilitate coordination.
Corporate Restructuring
Corporate debt restructuring involves the debt of a firm, and it takes place within a legal framework that provides for reorganisation or liquidation. In reorganisation, the firm continues to operate while its debts are restructured. In liquidation, the firm is wound up and its assets are distributed to creditors.
The framework determines the priority of claims and the rights of different classes of creditors. It also determines the scope for the firm to obtain new financing and to continue operating during the restructuring. The efficiency of the framework affects the cost of credit and the willingness of lenders to lend.
Consequences
Debt restructuring has consequences for the borrower, for the creditors, and for the wider economy. For the borrower, restructuring can restore sustainability and allow the resumption of growth. For creditors, it involves losses, which may be shared according to the terms of the restructuring. For the wider economy, restructuring can reduce uncertainty and restore confidence.
Restructuring also has consequences for future access to credit. A borrower that restructures may face higher borrowing costs and reduced access to credit for a period. This can discourage restructuring and delay necessary adjustments, a problem known as debt overhang.
The Sovereign Debt Crisis Experience
Sovereign debt crises have recurred throughout modern history, and the restructuring of sovereign debt has been a recurring feature of the international financial system. The Latin American debt crisis of the 1980s, the Brady Plan of the 1990s, and the restructurings of the 2000s and 2010s provide a series of episodes that illustrate the challenges of sovereign debt restructuring.
The Latin American crisis involved the debts of several countries to commercial banks, and the resolution required the coordination of hundreds of banks. The Brady Plan introduced the exchange of bank debt for bonds, which created tradable instruments and shifted the debt from banks to capital markets. This shift changed the nature of subsequent restructurings, since dispersed bondholders are more difficult to coordinate than a small group of banks.
The Greek restructuring of 2012 was the largest sovereign debt restructuring in history, and it involved a deep haircut on privately held debt. The episode illustrated the difficulties of restructuring within a monetary union, since the absence of a national currency removed a channel of adjustment, and it raised questions about the institutional framework for crisis resolution.
The Role of the IMF
The International Monetary Fund plays a central role in sovereign debt crises, providing financing and policy advice and assessing the sustainability of debt. The Fund's lending is conditioned on the implementation of policies that are intended to restore sustainability, and the design of these conditions is a subject of debate.
The Fund has developed a framework for assessing debt sustainability and for deciding on access to its resources. The framework distinguishes between cases in which debt is sustainable with high probability and cases in which it is not, and it determines the scale of adjustment and of financing that is required.
The Fund's involvement raises questions about the relationship between official and private creditors. In some cases, the Fund's financing has been used to service private creditors, which has been criticised as a bailout of the private sector. The design of the Fund's lending and the use of collective action clauses are intended to address these concerns.
Collective Action Clauses
Collective action clauses are provisions in bond contracts that allow a qualified majority of bondholders to agree to changes in the terms of the bonds and to bind the dissenters. They are designed to overcome the coordination problem that arises when a restructuring requires the consent of all bondholders.
The use of collective action clauses has become widespread, and they are now a standard feature of sovereign bonds issued under foreign law. Their design varies, and the details matter for the ease of restructuring. The clauses have been used in several restructurings, and they have facilitated agreements that might otherwise have been difficult to reach.
The effectiveness of collective action clauses is limited by their scope. They operate within a single bond issue, and they do not resolve the problem of coordinating across issues. The use of aggregation clauses, which allow a majority across issues to bind all, extends their reach, but the design remains a subject of debate.
Summary
Debt restructuring is a central feature of the international financial system, and its design determines the resolution of crises. The experience of sovereign debt crises, the role of the IMF, and the use of collective action clauses all shape the process and its outcomes.