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Navigating today’s debt restructuring landscape

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Navigating today’s debt restructuring landscape

The African continent was at the centre of the debt sustainability and restructuring debate even before the Covid-19 pandemic. Where a sovereign’s debt is complex and diverse, so too will be that debt’s restructuring. Recent African examples have highlighted this reality: countries’ creditors and debt arrangements may include a complex array of debts that are multilateral, Paris Club bilateral, non-Paris Club bilateral, syndicated, secured/resource-backed, unsecured, sharia-compliant, bonds (domestic and external) and yet others.

Diverse creditor composition requires sovereigns not only to manage different creditors’ priorities and approaches to restructuring, but also to navigate an assortment of instruments, each with varying terms and conditions.

Restructuring a complex debt portfolio would be challenging even if the sovereign were required only to address each debt individually, due to the sovereign facing imminent distress and the complexity of the underlying documents. But in a comprehensive sovereign debt restructuring, debt claims are not handled individually. In this scenario, where sovereign debt repayment capacity is limited, creditor coordination is required to appropriately allocate creditor gains and losses.

Attempts at creditor coordination

There have been attempts to address the perennial problem of creditor coordination in sovereign debt restructurings. Collective action clauses, for example, are ubiquitous in Eurobonds. They provide some relief by instituting voting mechanisms binding all holders to the terms agreed by a supermajority.

More modern versions of these clauses allow issuers to aggregate different Eurobonds, facilitating a cross-instrument restructuring.

These clauses still fall short, however, as they cannot be used across other types of claims (multilateral, bilateral or commercial loans).

Additionally, while the G20’s Common Framework (CF) aimed to address creditor coordination issues in sovereign debt restructurings, it has been limited in its ability to resolve the difficulties inherent in aligning diverse creditor groups. Indeed, the CF excludes multilateral lending and requires that any deal reached with official bilateral creditors be imposed on commercial creditors on “comparable terms”. Defining what it means for each creditor group to provide debt relief on “comparable terms” has been central to these challenges. As a result, coordination under the CF has remained difficult, and much needed debt restructurings have experienced drastic delays.

Beyond this, as recent examples have illustrated, the strategic interests of creditor countries can introduce an additional layer of complexity to African debt restructurings.

A global pecking order

Creditor classification and their corresponding rights complicate matters even further. There is a pecking order within the global financial architecture, with international financial institutions (IFIs) holding a de facto (rather than de jure) preferred-creditor status, which excludes such institutions from a restructuring. But which institutions qualify as an IFI? The lack of clarity on the response to this question has plagued many African sovereigns, with certain creditors using multilateral development bank status as justification for declining requests for debt restructurings.

In an April 2024 policy paper, the International Monetary Fund (IMF) attempted to provide clarity on how different creditor classes would be treated for the purpose of its lending policies, a move aimed toward clearing up this uncertainty and speeding up restructurings. While it is important to understand the IMF’s position on various creditor categories, however, it remains to be seen whether, and to what extent, such clarity will help borrowers.

Global discussions around how the international financial architecture can be improved to account for and respond to the above complexities are important. However, so too are conversations about what sovereign borrowers can do proactively to reduce the risk of encountering these challenges, a perspective that is often overlooked.

Pre-emptively build resilience

There are measures sovereign borrowers can take in advance to avoid unnecessary indebtedness, pre-emptively build their resiliency and bolster their responses to debt crises. These measures should start with adopting a robust legal, regulatory and institutional framework and improving debt management functions and capacities.

A country’s legal, institutional and regulatory frameworks are collectively the bedrock upon which effective debt management, which includes crisis prevention and resolution, is built. Countries should ensure that they have clear frameworks that outline processes and procedures and appropriately allocate duties, responsibilities and oversight to ensure that the rules are followed.

A framework with these characteristics will ensure the sovereign borrows within appropriate limits and can help to prevent a pick-and-mix approach to selecting financing sources. It also ensures that the borrower is fully aware of the challenges that may arise when dealing with certain creditors and credit structures.

Further, roles and functions within debt management offices (DMOs) should be clearly defined to ensure accountability and efficiency in managing public debt.

Debt management is a multifaceted job and requires a varied skillset and effective support systems. As such, comprehensive training should be provided to managers, and debt managements systems should be put in place to allow debt managers to effectively do their jobs. These measures should be informed by developed debt management strategies, borrowing plans to help guide decisions, and the employment of specialised tools for tasks such as debt recording and reporting.

Crisis prevention also includes sovereigns being selective about the credit they incur, understanding the universe of their creditors, negotiating favourable terms and seeking ways to innovate to ensure sustainability and resiliency. To that end, sovereigns should be deliberate about the debt they take on. Although sovereign debt is a public good, not all debt is good debt. While a financing option might seem attractive in the short term, it remains crucial to understand the implications, both positive and negative, of such debt in the long term.

Further, sovereigns must ensure they understand each credit’s terms, each creditor’s interests and, importantly, how the credit and the creditor might interact with each other from a debt management point of view and in the event a restructuring is required. It may also be appropriate to seek clarification from creditors on how they view their own classification as this may have a significant impact in a restructuring scenario. Such clarification should be obtained before the debt is incurred.

The terms of a sovereign’s debt contracts should be fit for purpose, not overly burdensome and allow the country to act should a modification to such terms be required or desired in the future. This means, inter alia, looking beyond what’s proposed as “standard” by creditors or their advisors to get the best deal for the country. All contractual terms are negotiable.

Sovereigns should explore innovative ways to enhance debt sustainability and build resilience into debt contracts. For example, state-contingent debt instruments, including debt pause clauses (for example related to climate or pandemics) can help mitigate risk by linking repayment capacity to repayment obligations.

Unfortunately, however, there are times when, even with the best frameworks, tools and preparation, debt crises arise – for example due to an external shock of severe magnitude. Then debt restructuring becomes necessary to restore sustainability. In this situation, it is best to act quickly rather than kicking the can down the road. It is also important to seek legal and financial advice as soon as possible to ensure the most optimal restructuring outcome.

Debt and debt restructurings can be complex and might seem daunting. However, with a clear understanding and appropriate preventative measures, sovereigns can effectively manage and navigate these challenges, ensuring debt is a benefit and not a burden.

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