Federal Department of Finance FDF

State Secretariat for International Financial Matters SIF

An international framework for restructuring sovereign debt Federal Council report of 13 September 2013 in response to the Gutzwiller postulate 11.4033 “An insolvency procedure for sovereigns”

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Contents

Mandate ...................................................................................................................... 3

1 Overview ........................................................................................................ 5

2 Sovereign debt and the international financial architecture ..................... 7

2.1 Trends in government debt ..................................................................................... 7 2.2 Creating debt sustainability ................................................................................... 10 2.2.1 Fiscal consolidation and debt reduction .................................................................... 10 2.2.2 Prevention of debt crises .......................................................................................... 10 2.2.3 Crisis resolution ........................................................................................................ 11

2.3 Principles for restructuring sovereign debt ......................................................... 12

3 Evolution of the current instruments ........................................................ 14

3.1 Creation of the Paris Club by official creditors (1956) ........................................ 14 3.2 Restructuring of international bank loans in the London Club .......................... 15 3.3 The Brady Deal (1989) and the securitisation of sovereign debt ....................... 16 3.4 Collective action clauses and SDRM as potential solutions for dealing with

crises in emerging economies .............................................................................. 16 3.5 Self-regulation; IIF Principles (2006) ..................................................................... 18 3.6 Debt crisis in the eurozone and the introduction of eurozone CACs ................ 19 3.7 Argentina's problem with holdouts ....................................................................... 19 3.8 Evaluating the current framework ......................................................................... 20

4 Reform proposals ....................................................................................... 21

4.1 Statutory approaches ............................................................................................. 21 4.1.1 Permanent courts ..................................................................................................... 21 4.1.2 Ad hoc courts of arbitration ....................................................................................... 22 4.1.3 Recourse to existing courts ...................................................................................... 22 4.1.4 Consultation and information sharing platforms (with no jurisdiction) ....................... 23

4.2 Contractual approaches ......................................................................................... 23 4.2.1 Collective action clauses .......................................................................................... 23 4.2.2 Other contractual elements ....................................................................................... 24 4.2.3 Standardisation of contractual elements ................................................................... 24

4.3 Switzerland's position ............................................................................................ 25

5 Conclusions ................................................................................................ 27

Figures ..................................................................................................................... 28

Abbreviations .......................................................................................................... 28

Further reading ........................................................................................................ 29

Annex I: Case studies .......................................................................................................... 31 Case 1: Argentina ................................................................................................................... 31 Case 2: St. Kitts and Nevis ..................................................................................................... 34 Case 3: Greece ....................................................................................................................... 36

Annex II: Collective action clauses ..................................................................................... 38 Eurozone CACs ...................................................................................................................... 38 G10 CACs ............................................................................................................................... 38

Annex III: Activities undertaken by Switzerland in relation to the postulate .................. 40

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Mandate

The Gutzwiller postulate 11.4033 "An insolvency procedure for sovereigns" was submitted on 30 September 2011 with the support of 27 signatories. In its reply of 30 November 2011, the Federal Council expressed its intention to present a report on this matter. The Council of States referred the postulate on 20 December 2011. Wording of the postulate The Federal Council is mandated to present a proposal for a fair and independent international insolvency procedure for sovereigns, which also involves private investors and contributes to avoiding future debt crises while ensuring the stability of the monetary and financial system. In its report, the Federal Council should also demonstrate how it intends to advocate for the international support and implementation of its proposal. Reasoning The global financial and economic crisis has caused many countries' debt situation to worsen, in some cases quite substantially. Some of the world's poorest developing countries whose debt had been largely cancelled prior to the crisis have also been affected. To date, however, there are no internationally recognised rules for dealing with highly indebted sovereigns facing insolvency. The need for such rules is exemplified at present by the situation in Greece. New refinancing is still being sought in an attempt to prevent Greece from defaulting. Nonetheless, the likelihood is growing that Greece will no longer be able to service its overwhelming debt load, and with it the voices calling for Greece to declare bankruptcy. An unspecified insolvency procedure would undoubtedly have very serious consequences. As a result, the financial markets are jittery, with direct repercussions on Switzerland – in addition to effects from the strength of the Swiss franc. This situation also creates difficulties for some critically indebted countries in the southern hemisphere: these are left to face the crisis on their own, at the mercy of their creditors' interests and decision-making. On top of that, vulture funds are dragging them before courts to force repayment of some questionable debts. Switzerland already proposed a possible alternative in the early 1990s with the idea of an insolvency law for sovereigns. This would require: - an insolvency procedure for states that encompasses all creditors and all debts, - an impartial decision-making model (e.g. an independent court of arbitration), and - an impartial judgement; the IMF and the World Bank cannot act as both creditor and appraiser at the same time without risking a conflict of interests. An orderly debt restructuring procedure would offer debtor countries as well as their creditors the benefits of a predictable and reliable framework. The procedure would be such that it respects each country's national sovereignty and does not create false incentives for debtors to take on even more debt. Also, an impartial approach would, for the first time, offer the possibility of having the legitimacy of creditors' claims checked in the verification of claims framework. This could create an incentive in favour of more responsible lending. Given its strong position in bodies such as the Financial Stability Board, Switzerland would

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be well placed to also promote international implementation of such rules. Statement by the Federal Council on 30 November 2011 The Federal Council is concerned by the sharp deterioration of the debt situation in most advanced countries and in some of the world's poorest countries. In this respect, the importance of a prudent economic policy and the creation of suitable mechanisms for consolidating fiscal balances cannot be overemphasised, and, in particular, measures to help prevent over indebtedness. However, for those countries that have already amassed too much debt on the international capital market, the creation of an international insolvency procedure could also be of interest. In the current situation, a discussion on the creation of such an insolvency procedure should be clearly separated from measures to resolve the present debt problems of some individual states, particularly in the euro area. An insolvency procedure could contribute to resolving such problems in the future. However, immediate solutions must be based on the current framework, which do not by any means rule out a sustainable solution to the debt problem. Nonetheless, a predictable framework and process to overcome the problem of coordinating claims of different domestic and international creditors would contribute to finding a solution. With regard to measures for dealing with over indebtedness, a distinction should also be made between cancelling poor countries' debts and debt restructuring in countries that obtain most of their financing on the international capital market. The debt of poorer countries is primarily owed to bilateral and multilateral official creditors and, to a large extent, was addressed by the international HIPC and MDRI initiatives. With countries that obtain most of their financing on the international capital market, the coordination of a highly diverse creditor base is considerably more complex. The restructuring of internationally held sovereign debt should generally be regarded as part of a package of measures to create a sustainable economic environment. As a rule, such packages also include financing within the context of an IMF programme to support the implementation of reforms in economic policy. However, too much financial support increases the danger of creditors again underestimating the risk of default in the future, as they come to rely on international support, and disregarding their duty of due diligence in extending finance. An international insolvency procedure could therefore lead creditors to a more sustainable lending model. Meanwhile, there would have to be guarantees that debtor countries obtain no incentives to wilfully declare bankruptcy. The IMF will and must play a key role in such complex issues of the international financial architecture and its dual function as both creditor and assessor will remain unavoidable. For this reason, particular attention must be given to the principles of transparency in funding and a strict supervision of the IMF by its member states. Switzerland was a strong advocate within the IMF for the creation of an insolvency procedure for states, the Sovereign Debt Restructuring Mechanism (SDRM) from 2000 to 2002. Although the work specifically related to the SDRM has been suspended, Switzerland has continued to promote the benefits of further work on such an insolvency procedure within the IMF and other relevant international financial bodies. The Federal Council is therefore prepared to present the Federal Chambers a proposal for an orderly restructuring of sovereign debt and to promote it internationally. Federal Council motion of 30 November 2011 The Federal Council proposes that the postulate should be accepted.

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1 Overview

The Gutzwiller postulate 11.4033 "An insolvency procedure for states" of 30 September 2011 mandates the Federal Council to "present a proposal for a fair and independent international insolvency procedure for states, which also involves private investors and contributes to avoiding future debt crises while ensuring the stability of the monetary and financial system. In its report, the Federal Council should also demonstrate how it intends to advocate for the international support and implementation of its proposal." The Federal Council adopted the postulate on 30 November 2011. It argues in this report, that the absence of a reliable framework for sovereign debt restructuring constitutes a gap in the international financial architecture. Switzerland should therefore continue to support the creation of a more robust framework for restructuring sovereign debt within the relevant international bodies such as the International Monetary Fund (IMF), the Financial Stability Board (FSB), the Paris Club and the G20. The objective of such a framework should not be debt reduction per se or debt relief motivated by development policy but the formulation of reforms that contribute to improving the functioning of markets. The Federal Council proposes that Switzerland support measures to enable a more systematic inclusion of different creditors in debt restructurings. The report shows that this mainly concerns possible international agreements on amendments to sovereign bond contracts. As shown in Chapter 2, the current rise in debt worldwide is a worrying trend. The euro area debt crisis raises, above all, the question of how such situations can be better prevented in the future. At the same time, the development of the crisis makes clear the desirability of a more effective crisis resolution – including a more robust framework for dealing with sovereign insolvency. The report spells out principles for such a framework, which should be part of the reforms for a more stable global financial system with well-functioning markets. Chapter 3 describes the evolution of the existing instruments for restructuring sovereign debt. While the current framework is flexible and can adapt to special circumstances, the outcomes it has produced to date are, overall, not satisfactory. Debt restructurings have often been too little and too late, increasing the financial burden on the official sector. The need to coordinate a heterogeneous creditor base across different jurisdictions makes any possible solutions difficult to implement. Also, those creditors who refuse the restructuring deal, so-called holdouts, pose a threat to finding a generally acceptable solution. Chapter 4 presents the main current proposals for reforming the framework for sovereign debt restructuring and evaluates their feasibility. Basically, these proposals can be divided into statutory approaches, which foresee some form of institutionalised jurisdiction, and approaches based on sovereign debt contracts. It is shown that while there already exists a wide range of proposals, there is very little international support at present for discussing holistic reform approaches. Against this background, the report shows how the work can nonetheless proceed in pragmatic steps based on the contractual approach. Chapter 5 draws conclusions for Switzerland's further engagement in favour of a more robust international framework for restructuring sovereign debt. This report also serves to fulfil the Eymann postulate 00.3103. The Eymann postulate 00.3103 "Creation of arbitration proceedings for reconciliation of interests between debtor countries and creditors" of 20 March 2000 called upon the Federal Council to "work with like-minded countries to create independent and transparent arbitration proceedings for the reconciliation of interests between debtor countries and creditors, particularly for the establishment of an international insolvency law." On 4 October 2000, the National Council

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referred the motion in the form of a postulate at the request of the Federal Council. The Federal Council believes that the Eymann postulate 00.3103 is also fulfilled by the present report and will therefore propose its dismissal.

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2 Sovereign debt and the international financial architecture

The current rise in government debt levels worldwide is a worrying trend: high public debts crowd out private enterprise, limit states' room for manoeuvre, burden future generations and can, when there are doubts concerning the ability to service debts, pose a threat to financial stability and thus also economic growth. The global financial crisis, which originated in the US subprime mortgage crisis in 2007, and the subsequent sovereign debt crisis in the euro area caused public debt to rise sharply in most industrialised countries. Several countries – Iceland, Ireland, Portugal, and Cyprus – needed massive international support programs with drastic fiscal adjustments to continue to be able to service their debts. In the case of Greece, the restructuring of sovereign debt held by private investors was part of a reform package supported by the eurozone countries, the European Central Bank (ECB) and the IMF. The costs of this package are enormous. Above all, the euro area debt crisis raises the question of how such situations can be better prevented in the future. At the same time, the development of the crisis makes clear that more effective crisis resolution would be desirable – including a more robust framework for dealing with sovereign insolvency. The according work must take place in the context of the reforms for a more stable global financial system with well-functioning markets.

2.1 Trends in government debt

Figure 2.1 summarises debt developments worldwide over nearly the past 100 years, showing a broad historical perspective of debt-to-GDP ratios in large advanced, emerging and low income countries. Figure 2.2 also shows the debt-to-GDP ratios of some of the world's leading economies in the years 1960, 1980, 2000 and 2012. Figure 2.1: Global debt developments since 19201 (adjusted for purchasing power)

1 Source: IMF, Fiscal Affairs Department; 2012 data based on provisional estimates

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Figure 2.2: Debt-to-GDP rates of selected countries in 1960, 1980, 2000 and 20122

Country 1960 1980 2000 2012

54.3 42.3 54.8 106.5 USA Canada 66.1 45.6 82.1 85.6

18.4 31.3 60.2 82.0 Germany UK 117.9 46.2 50.3 90.3 France 28.5 20.7 57.4 90.3* Italy 31.4 56.1 108.5 127.0 Ireland 44.9 56.1 37.8 117.1 Spain 20.5 17.2 59.4 84.1 Portugal 16.4 29.6 48.4 123.0* Greece 11.6 22.6 103.4 158.5 Cyprus 20.5 59.6 86.2 Iceland 8.7 41.0 99.1*

Japan 8.0 52.8 140.1 237.9* Australia 31.5 21.3 19.5 27.2

14.9 33.1 68.5 68.5 Brazil China 16.4 22.8 India 36.5 41.3 72.7 66.8 Mexico 4.6 31.4 42.6 43.5

Switzerland 16.2 43.9 59.9 49.1* In all of the large advanced countries, debt ratios trended up since the 1990s and rose sharply after the 2007 financial crisis. This was driven by debt in Japan, the US and the euro area. Despite efforts to consolidate their public finances, these countries are likely to see their debt rise even further. The IMF expects debt ratios to peak in 2014, although it remains unclear how quickly the burden can be reduced. Advanced countries generally place their debt on the market. Until recently, their sovereign bonds were commonly seen as safe investments. Their main creditors are domestic and international banks, central banks, state funds and institutional investors. Emerging economies have generally managed to maintain stable public debts over the past ten years, thanks to robust growth as well as low interest rates worldwide. The vast future demands in these countries to build up infrastructure and social security networks are likely to increase the pressure on public spending. Higher interest rates and, as in most advanced countries, the challenges of ageing populations could bring emerging economies' public finances under pressure. Emerging economies finance themselves predominantly by accessing international financial

2 Source: IMF, Fiscal Affairs Department; * indicates provisional data

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and capital markets, making them vulnerable to fluctuations on these markets. They are also the biggest customers of the World Bank and the regional development banks. On average, the debt ratio of low income countries has more than halved since the 1990s, mainly due to the generous debt relief by bilateral and multilateral creditors. The Heavily Indebted Poor Countries (HIPC) Initiative launched in 1996 produced debt relief of some USD 76 billion. This was primarily borne by the official creditors of the Paris Club (36%), the World Bank (20%), other official bilateral creditors (13%), the IMF (9%) and other multilateral creditors. At 6%, the proportion of debt relief from commercial private creditors was comparatively low. The HIPC Initiative was enhanced by the Multilateral Debt Relief Initiative (MDRI), launched in 2005 by the G8. It brought the cancellation of the entire multilateral debt of heavily indebted poor countries with the IMF, the World Bank and the African Development Bank (AfDB). This was intended as a contribution to meeting the United Nations' Millennium Development Goals (MDGs) and to helping these countries to achieve debt sustainability. Together, HIPC and MDRI have reduced the debt levels of highly indebted poor countries by an average of 90%. Debt service was cut by an average of 2% of economic output. At the same time, there was an increase in spending on poverty reduction. The approach taken by HIPC and MDRI was holistic and focused on strengthening national institutions to support poverty reduction and growth strategies. Most of the countries significantly improved their economic policy toolkit and particularly their fiscal and debt management capacities. Debt levels are, nonetheless, rising again rapidly in some of the more dynamic countries (e.g. Ghana, Senegal, Tanzania and Uganda). Against this background, it remains uncertain whether an excessive increase in public debt can be sustainably prevented. Since debt relief was granted, the composition of the creditor base has changed markedly: whereas up to 98% of creditors in the 1980s and 1990s were multilateral and traditional bilateral creditors, recent years have seen a return of private capital flows into poorer countries. This is due, on the one hand, to the more credible and sustainable economic policies pursued by these countries. On the other hand, it is also a result of low interest rates worldwide, making the relatively higher yields on investments in developing countries increasingly attractive. More and more HIPC countries can now access international financial and capital markets and thus issue sovereign bonds. Some 10% of developing countries' debt is now held by private creditors. The growing significance of private capital markets in developing countries raises new challenges and makes them more vulnerable to global market developments. For several years now, "new creditors" such as China, Brazil and India have come to play an important role in financing. These invest in low income countries, where they cover a significant portion of their demand for raw materials. There is often a degree of uncertainty regarding the terms on which according loans are granted and how they fit into the development architecture. The lower debt levels in low income countries achieved through HIPC and MDRI, the changing role of emerging market economies and the growing debts of advanced countries are the main reasons behind the lack of international support for further debt cancellation for low income countries. In addition, a global framework for restructuring sovereign debt would, in principle, apply to all countries.

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2.2 Creating debt sustainability

The above makes clear that achieving and maintaining debt sustainability is a great global challenge. Without sustainable debts, it will hardly be possible to stabilise the global financial system. Ensuring debt sustainability is, essentially, the responsibility of the debtor country, which contains its debts through a prudent conduct of fiscal policy. Private and official creditors make an important contribution to preventing debt crises by conducting appropriate risk assessments and by ensuring that a risk-adjusted interest rate enforces discipline on the debtor countries’ lending patterns. This requires corresponding market-based incentives for creditors to assess risks adequately, which are closely linked to the rules and practices of the national and international official sector. A stronger general framework to ensure sustainability of debts therefore requires good coordination and general consistency between the individual countries' reform efforts and the international financial architecture. In this respect, the efforts to strengthen the IMF's surveillance activities – which include members' debt sustainability analyses – play a pivotal role. The IMF's surveillance of members’ economic policies is, however, beyond the scope of this report.

2.2.1 Fiscal consolidation and debt reduction

In the current environment of modest global growth, stabilising or reducing debts poses particular challenges for economic policies. Carefully designed retrenchments have a positive impact on medium and long-term growth prospects and can substantially influence expectations in the short term. Therefore, fiscal consolidation must not necessarily be inconsistent with efforts to promote growth. However, this does require acceptance and adoption of credible measures that are well targeted and well timed. In principle, the international community is aware of the positive long-term impact of conservative fiscal policies, as repeatedly stated, for example, in G20 initiatives as well as the IMF’s analyses and policy recommendations. Many countries are, nonetheless, hesitant to adopt and implement concrete measures. This means that the road to debt sustainability could well remain a long one. Switzerland is, in international bodies such as the IMF and the G20, a strong advocate of setting and implementing credible consolidation targets. Despite some exceptions, it must be recognised that the main reason behind persistent fiscal deficits is the lack of structural reforms and an inadequate assessment of risks. For example, the materialisation of risks from contingent liabilities related to large financial institutions led to enormous burdens on public finances in many countries.

2.2.2 Prevention of debt crises

Debt sustainability reflects a country's willingness to use official funds sensibly and economically and to take a prudent approach to long-term debt management. Governments must, above all, keep their own houses in order, meaning that the implementation of sustainable fiscal policies should be accompanied by structural and financial sector reforms. Sustainable debt management comprises a complex interaction between monetary, fiscal and financial sector policies. This poses a particular challenge to states with weak institutions. Switzerland therefore supports international initiatives and projects that support developing and emerging economies in attaining sound public finances and which enhance their competitiveness and integration into the global economy. This includes measures such

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as the reinforcement of debt management capacities, mobilisation of the country's own tax revenues, responsible use of official funds and the promotion of a stable and strong financial sector. Fiscal rules can play an important role in ensuring medium-term sustainability of public debts. Switzerland's experience with the debt brake shows that clear budgetary targets are by no means incompatible with growth; in fact, they can actually go towards creating confidence on the markets. However, the credibility of fiscal rules depends on the relevant countries having a sound track record. Countries' debt management could be generally improved with a more systematic risk assessment and the inclusion of this in fiscal planning. This also includes improving transparency in public accounting and the corresponding international tools. This is particularly evident from two examples from the euro area debt crisis: The correction of Greece's budget deficit in the wake of the crisis was due to the fact that the authorities did not have reliable figures on the actual debt situation. In Portugal's case, the lack of transparency on liabilities incurred as part of Public Private Partnerships resulted in the actual level of government debt being significantly underestimated. There is, therefore, a pressing need to strengthen and harmonise the rules for public accounting, to ensure their systematic implementation and to support states with weak public institutions. The IMF, in particular, is reviewing its toolkit for overseeing its members’ budgetary situations. At the same time, several international bodies (IMF, OECD, World Bank, UNCTAD, and G20) are currently working on establishing internationally recognised practices for debt management and debt financing. Of particular importance are the IMF's debt sustainability analyses, which help to identify non-sustainable debt developments as early as possible. Private creditors also make an important contribution to preventing debt crises. As shown in the case of the euro area debt crisis, imprudent risk assessments can exacerbate the impact of a debt default on the international financial system. Misjudgements can seriously impact the functioning of money and capital markets over many years. In turn, bank bailouts, i.e. the use of substantial official funds to recapitalise financial institutions, also cause public debt to increase sharply. The vicious circle between public debt and undercapitalised banks can then have a destabilising effect on the real economy. Reforms in the international financial system seek to break this vicious circle, among other things, by making private creditors take responsibility for assessing credit risks. This includes a review of the risk assessment models and accounting rules. Rating agencies should detect potential risks more accurately and communicate these faster so as to create added value among market participants. Also, systemically relevant financial institutions should adopt additional precautionary measures in the form of stricter capital and liquidity requirements. Finally, the rules for the resolution of banks should be made more predictable. At the same time, the IMF and the FSB are pushing forward reforms for stronger prudential supervision of the financial system and of economic policies, with the G20 playing a significant role.

2.2.3 Crisis resolution

Even if preventative measures can be stepped up considerably, it will most likely not be possible to prevent future financial and debt crises entirely. A well-designed and effective toolkit for crisis resolution will therefore continue to be necessary. Where crises are of global nature, the international official sector is of particular significance. Above all, this includes the multilateral institutions of the IMF, the World Bank and regional development banks as well as other countries or country groups and their central banks.

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The goal of international intervention in crisis resolution is to stabilise the situation and prevent it from spreading to other countries or regions. The extent of intervention is largely determined by the perceived risk of such a crisis spreading regionally or internationally. Generally, the objective is to restore public finances to a long-term sustainable level through fundamental institutional and economic reforms. Fresh funds should be made available temporarily to bridge the time until necessary adjustments have been made. In the past, international official sector support has, in most cases, helped to overcome crisis situations and prevent them from spilling over into other countries and regions (e.g. Mexico, Brazil, Turkey, Uruguay, Iceland, and Ireland). There are, however, also risks and distortions associated with official sector involvement. If the debtor country and its creditors can expect the official sector to provide emergency financing, this will affect the way default risk is assessed. In this respect, the official sector's financial engagement can, in principle, create moral hazard among both, creditors as well as debtors. If a sustainable debt situation cannot be restored through bridge financing, the debt will have to be restructured. This implies that private creditors are also involved in financing the resolution of the crisis. Such private sector involvement is compatible with IMF policy, which permits lending into arrears, provided that the debtor country is negotiating in good faith with its private creditors a restructuring of its debts. In reality, however, both the debtor country and its creditors have a natural tendency to avoid debt restructuring whenever possible. Debtor countries fear that restructuring will damage their long-term reputation as being willing and able borrowers and thereby sharply increase their financing costs due to the higher perceived credit risk. Large creditor banks fear the loss of market and investor confidence because of their risk positions, which could also trigger the need to recapitalise. For one thing, this results in unsustainable situations dragging on for years – a situation from which neither the country nor its creditors stand to benefit. It also ties up official funds excessively, thereby transferring the burden from the private to the official sector. Finally, avoided restructurings increasingly distort markets’ assessment of the risks associated with government bonds.

2.3 Principles for restructuring sovereign debt

High public debts crowd out private enterprise, limit states' room for manoeuvre, burden future generations and can, when there are doubts concerning the ability to service the debts, pose a threat to financial stability and thus also economic growth. The current reforms of the international financial architecture must ensure that countries bring their debts to sustainable levels as quickly as possible, that they establish the instruments and institutions to prevent debts from building up again, and that the markets for sovereign bonds function more smoothly. The last point, in particular, means that default risks are appropriately assessed and priced. As long as excessive engagements of official funds are used to avoid sovereign insolvencies, markets will not assess risks accurately. Improving the functioning of markets is thus a core motivation for creating a more predictable framework for restructuring sovereign debt. Based on the above discussion, the Federal Council derives the following principles for a more robust framework for restructuring sovereign debt:

Crisis resolution should seek a fair burden sharing among all creditors. The inclusion of private creditors in crisis resolution should, in particular, be better anchored in the international financial architecture.

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The restructuring of sovereign debt must find acceptance as a credible measure of last resort: → The existence of a reliable framework would act as a deterrent, reducing creditor and debtor moral hazard and thereby improving the assessment of sovereign bond risks. → An orderly framework for restructuring sovereign debt would ensure greater predictability and make it easier to achieve a long-term sustainable debt situation across borders.

The objective of restructuring should not be debt reduction per se. Instead, it should form part of the reform measures to put the economy on a path that is sustainable in the long-term.

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3 Evolution of the current instruments

The instruments currently available for restructuring sovereign debt have evolved in different waves. While sovereign insolvencies have occurred for centuries, the roots of the current approaches to deal with them lie in the period between the 1950s and the 1970s, when a number of emerging economies and developing countries became excessively indebted to traditional creditor countries and to bank syndicates. When it came to renegotiating these debts, the various international creditors needed to be treated as equally as possible. This resulted in the creation of two informal groups: the Paris Club, for the debtor country's negotiations with its official creditors, and the London Club for coordinating the negotiations with commercial banks. The Latin American debt crisis of the 1980s was resolved by splitting up and re-securitising bank debts. This started the spread of internationally issued and traded sovereign bonds, which, in turn, fundamentally altered the creditor structure of emerging economies. With regard to debt restructurings, the changed structure of lending exacerbated the problem of coordinating an increasingly heterogeneous creditor base and the risk of "holdout" creditors. The lack of an orderly framework to deal with sovereign insolvency again came to the fore with the crises in emerging economies in the mid-1990s, where private creditors played a dominant role in negotiations. With a view to bridging this gap, the IMF discussed the possibility of a Sovereign Debt Restructuring Mechanism (SDRM) in the period between 2001 and 2003. Such a mechanism failed to attract majority support among the international community, however, and was opposed by the large international banks. Nonetheless, these discussions did make a contribution to defining the key aspects of sovereign debt restructurings. The SDRM also helped to advance the broader introduction of collective action clauses (CACs) in bond contracts. Through the creation of the European Stability Mechanism (ESM), CACs have now become a regional standard.

3.1 Creation of the Paris Club by official creditors (1956)

The Paris Club3 is an informal group of industrialised nations4 which coordinates the rescheduling of bilateral official debts of low income and emerging market countries. The sole object of discussion within the Paris Club is public debt and government-backed assets of creditor countries, which are also guaranteed by the debtor country. Depending on its debt situation and state of economic development, a debtor country may qualify for different debt rescheduling conditions. The Paris Club grew out of talks held in 1956 to renegotiate Argentina's debt. Originally, Paris Club agreements covered only the extension of maturities and did not include debt reduction. This changed in the 1980s when a number of very poor countries were unable to continue servicing their debts. With the establishment of the HIPC Initiative in 1996 (cf. Section 2.1), the Paris Club began to play a key role in debt relief for some of the world's poorest countries. To date, the Paris Club has concluded more than 428 debt restructuring contracts with 90 debtor countries, covering a total of USD 573 billion of debt. Decisions within the Paris Club are taken according to its own rules and principles, the main ones of which are:

3 Cf. also http://www.clubdeparis.org/ 4 The permanent members of the Paris Club are: Australia, Austria, Belgium, Canada, Denmark, Finland, France,

Germany, Ireland, Italy, Japan, Netherlands, Norway, Russia, Spain, Sweden, Switzerland, United Kingdom and United States.

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Case-by-case debt treatment: The Paris Club makes decisions on a case-by-case basis in order to tailor its action to each debtor country's individual circumstances and needs. This aims to address the extraordinary nature of each debt restructuring. Consensus: All decisions are taken by unanimous vote among the members. This ensures a degree of solidarity between official creditors. Conditionality: The Paris Club negotiates debt restructurings only with debtor countries that are committed to implementing reforms under an IMF programme. Solidarity: All members of the Paris Club agree to act in a manner that ensures that the burden of debt restructuring is more or less equally distributed among all members. Comparability of treatment: The debtor country guarantees that no other creditor obtains a more favourable deal. If private creditors or non-members receive better restructuring terms, members of the Paris Club are also entitled to higher payments. This does not concern the preferred status of multilateral creditors. In the past, the Paris Club has played a key role in debt restructurings. Recent developments have caused it to lose some significance, however. For instance, debt relief in the poorest countries is now largely complete under the HIPC Initiative. As briefly mentioned in Chapter 2, the nature of debt has also changed considerably, particularly among the world's poorer countries. New creditors have appeared, such as China, India and Brazil, which were not previously members of the Paris Club and thus have participated only marginally in debt cancellation. Also, more and more lower income countries are now seeking finance on the international capital market. This raises the question as to how the Paris Club could share its vast experience in orderly debt rescheduling negotiations in the future.

3.2 Restructuring of international bank loans in the London Club

The London Club emerged alongside the Paris Club as an informal grouping to renegotiate official debt owed to international commercial banks. It originated in the 1970s, when commercial banks (again) increasingly assumed the role of state creditors, particularly in Latin America. At the time, commercial banks also joined forces in syndicates so as to be able to offer larger loans to official debtors. As a rule, these syndicated loans were denominated in foreign currency and carried a variable interest rate. In the early 1980s, rising interest rates worldwide and depreciating currencies in many emerging market and developing countries contributed to a debt crisis. Mexico (1982) and a number of other countries, mainly in Latin America, were no longer able to service their debts to international banks. As most loans had been granted by bank syndicates, they contained a "cross default clause", whereby the failure to service one creditor can trigger the default for all other creditors. This means that the costs of a non-payment to one bank in the syndicate would have to be borne proportionately by all the other banks. As a result, the banks forming a syndicate were forced to enter into joint negotiations with the relevant governments. With some loans involving up to 500 banks, it was clear that reliable creditor coordination was needed. The banks with the greatest interest in the loans joined together to form ad hoc groups called Bank Advisory Committees. These generally met in London, hence the name. The negotiating structure within the London Club proved effective for the challenges faced at the time: the number of majority banks was limited, and their interests contributed to a positive negotiating outcome. Many banks were in favour of extending additional loans to debtor countries so as to avert a payment default. This gave them extra time to increase their

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reserves against default. Also, many commercial banks were anxious to maintain a good relationship with the debtor country. There was therefore limited interest in insisting on immediate repayment of the entire debt and in pursuing legal action. In principle, the ad hoc system of the London Club still exists. However, the increased diffusion of government bonds has greatly altered the creditor composition and thus also the role of international banks (cf. Section 3.3). Long-term relationships between a debtor country and its creditors – a situation that once contributed to finding a solution – have become rarer. With the International Institute for Finance (IIF), a centralised lobby of large international banks has been established (cf. also Section 3.5).

3.3 The Brady Deal (1989) and the securitisation of sovereign debt

The 1989 Brady Deal brought a resolution to the Latin American debt crisis. The deal converted bank loans at a discount into "Brady bonds", which were backed by US Treasuries and loans from the IMF and the World Bank. The banks could then trade in loans that were no longer serviced. The creation of Brady bonds quickly led to the spread of standardised government bonds that were easy to trade in markets. One of the lessons from the Latin American debt crisis was the realisation of the huge risks inherent to extending large bank loans to official creditors, particularly emerging economies with poorly developed markets. With the exchange of traditional bank loans (at a discount) for standardised and tradable Brady bonds, risks could be better spread and priced. The growth of securitised bonds opened up new investment opportunities for smaller and more anonymous investors. The diversification of the creditor base changed the incentives of creditors, who were not necessarily as interested as the banks in securing follow-up business in the relevant countries. With regard to a framework for restructuring sovereign debt, the Brady Deal paved the way for a more diverse international creditor base. This, in turn, made short-term valuation more important, making the reliability of the markets’ risk assessments all the more crucial. Furthermore, the variety of jurisdictions now issuing bonds has made debt restructuring even more complex and costly and achieving an even-handed treatment of all creditors more difficult. On the other hand, the securitisation and international tradability of debt have given emerging markets and developing countries much easier access to global capital and thus greater financing opportunities.

3.4 Collective action clauses and SDRM as potential solutions for dealing with crises in emerging economies

The crises that hit emerging market economies (Mexico, Korea, Brazil, Russia, Argentina, Uruguay) in the mid-1990s increasingly highlighted the problems associated with a diverse and international group of creditors. Access to the ever more dynamic international financial markets had given these countries a means of covering their significant capital needs. They seized the opportunity to raise funds in different countries and currencies, spreading their external debt over a highly diverse international creditor base. The main places of issue for emerging market bonds were traditionally London and New York, followed by others such as Frankfurt, Zurich and Tokyo. As a rule, the place of issue determines the terms of the bond, the applicable law and the place of jurisdiction. Thus, apart from the increased heterogeneity of creditors, there was also greater diversity in terms of legal procedure. Clearly, any debt restructuring that became

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necessary could be expected to involve long and costly negotiations and procedures. In seeking ways to prevent costly debt workouts, renegotiation of the payment terms for bond contracts became relevant: while bonds issued under English Law generally allowed for a renegotiation of payment terms, New York-issued securities explicitly excluded this possibility.5 The market had overlooked this fundamental contractual difference for decades, with no difference in price between similar issuances in New York and London. One reform measure pursued by the Group of Ten (G10)6 since 1995 was the introduction of collective action clauses (CACs) in government bonds issued under the laws of foreign countries (cf. also Section 4.2 and Annex II). This aimed to allow for the restructuring of bond contracts and eliminate the problem of holdouts, i.e. creditors who reject a restructuring deal and subsequently take legal action to assert their contractual rights. Based on the work of the G107, a large portion of the bonds issued by emerging market economies abroad have contained CACs since 2003. From 2001 to 2003, the IMF held talks with the international community, the private sector and a broader public on the establishment of an institutionalised insolvency procedure for states, the Sovereign Debt Restructuring Mechanism (SDRM). The SDRM sought to address not only the problem of holdout creditors but also that of collective action, given a diverse international creditor base. The introduction of CACs was meant to be a complementary element of the mechanism. The SDRM's main objective was to provide strong incentives for debtor countries and their creditors to reach a consensus quickly and in an orderly and predicable fashion and thereby bring about a long-term sustainable situation. The very existence of the SDRM, i.e. the possibility of debt being restructured, was supposed to work as a deterrent for creditors and debtors alike, so the SDRM would ideally never need to be activated. Only the debtor country would have been able to activate the SDRM, by demonstrating its inability to reach a sustainable debt situation. The basic pillars of the SDRM were debt restructuring by way of a qualified majority decision, the possibility of a temporary debt moratorium, creditor protection, and mechanisms to raise fresh funds. Supervision of the process was to be transferred to a Sovereign Debt Dispute Resolution Forum (SDDRF), an independent international body of arbitrators. The SDRM could have been established through an amendment of the IMF Articles of Agreement, requiring an 85% majority within the IMF. This would have created new international legislation as the SDRM's restructuring decisions would have been internationally binding, requiring the revision of national laws. Most of the support for the SDRM came from Europe, Canada and Japan. The emerging market economies, at which the mechanism was targeted, remained highly sceptical. For its part, the US used the discussions on the SDRM to advance the introduction of CACs: immediately after the G10's model CACs were published, the US succeeded in suspending IMF talks on the SDRM. Many countries thought the loss of sovereignty associated with the internationally binding force of restructurings under the SDRM to be too great. The private

5 In fact, under the US Trust Indenture Act of 1939, bondholders could not be forced to waive their rights from a

bond contract. 6 The G10 was founded in 1962 by the world's leading industrialised countries. The founding members (US, Canada, UK, France, Germany, Italy, Belgium, Netherlands, Sweden and Japan) extended extraordinary loans to the IMF under General Arrangements to Borrow (GAB). Switzerland became the 11th member of the G10 in 1983. 7 Group of Ten (2003). Report of the G-10 Working Group on Contractual Clauses. Washington, D.C.

http://www.bis.org/publ/gten03.pdf

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sector also exhibited a largely negative attitude towards an institutionalised procedure. The main achievement of the SDRM was the systematic consideration given to complex restructurings with a large creditor base in different jurisdictions. Although it continues to have only little backing, as is likely the case with most other proposals having international legal effect (cf. Section 4.1), the SDRM does provide a holistic and timely approach to resolving the main problems of restructuring sovereign debt that is held by a diverse and international creditor base.

3.5 Self-regulation; IIF Principles (2006)

The period following the rejection of the SDRM in the spring of 2003 was marked by a robust global economy and relative calm on international financial markets. Many countries took this opportunity to reduce their public debts. The International Institute of Finance (IIF), the association of the largest international banks, utilised this favourable environment to promote an approach of self-regulation. The IIF had been a firm opponent of the SDRM and, originally, the IIF had also had serious reservations about CACs. This changed with the work of the G10 in 2003. Then in 2006, together with representatives of the main emerging markets, the IIF adopted general, non-binding principles for public debt. These principles advocate introducing CACs and include non-binding principles for crisis resolution and debt restructuring. A key element of the principles is the terms and conditions for the cooperation of the debtor country with its creditors. The focus here is on transparency, timely information, regular dialogue and cooperation, good-faith actions, and fair treatment of creditors. The IIF has since then led creditors in a series of restructuring negotiations, e.g., with Greece. Based on this experience, the principles were revised in 2012 and basically extended to all debtor countries. The IIF principles8 are non-binding and constitute a useful basis for discussion. Given the IIF's many references to Greece in the revised principles, it is quite clear that these are still a work in progress and not yet a refined framework. On certain points, such as the independent drafting of debt sustainability analyses, they are not compatible with IMF policy. Also, the principles establish relatively more obligations for the debtor countries than for creditors, a fact that could jeopardise their general legitimacy. The IIF principles contain useful recommendations for restructuring government debt. For cooperative, rapid and adequate debt restructuring, however, they do not constitute a robust framework of action. The main points of relevance for future discussions are likely to be:

- Interest: The private sector appears to have an interest in establishing a stable framework.

- Flexibility: A certain degree of flexibility is important, as demonstrated by a range of aspects in the case of Greece.

- Representativeness: It is not clear whether the IIF, which represents the interests of large international banks, can appropriately represent all creditors.

- Responsibility: More clarity is needed regarding the division of duties and responsibilities between creditors and debtors.

- Soundness: Very little has been said to date about the delays in restructuring on account of some European banks being too thinly capitalised.

8 Cf. Principles for Stable Capital Flows and Fair Debt Restructuring.

http://www.iif.com/download.php?id=mUq/5udGdME=

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3.6 Debt crisis in the eurozone and the introduction of eurozone CACs

The prospect of sovereign insolvency in Greece and other eurozone countries gave rise to the creation of the European Financial Stability Facility (EFSF). This European rescue fund was soon thereafter transferred to the European Stability Mechanism (ESM), a permanent crisis resolution mechanism for eurozone countries. The ESM came into force on 27 September 2012, offering support for eurozone countries with severe financing difficulties, under certain economic-policy conditions, through loans from the community of euro states. The treaty establishing the ESM provides for the creation of a permanent facility with a credit volume of EUR 500 billion. Another element of the treaty is the introduction of CACs for all government bonds newly issued by eurozone countries from 1 January 2013.9 Known as eurozone CACs, these are a further development of the G10's model CACs published in 2003 (cf. Annex II). In particular, they include an aggregation clause whereby restructuring decisions can be made to apply to different issuances. The case of Greece (cf. Annex I) was instrumental in resuming the international discussions on state insolvency in the following aspects:

- Consensus existed at an early stage on the need for debt restructuring. Delaying such action turned out to be extremely costly for most stakeholders. A particular problem is the extraordinarily high engagement of official funds, which replaced private engagement.

- Debt contracts subject to domestic law provide room for manoeuvre in the case of debt restructuring. This is likely to create considerable uncertainty in future cases.

- Flexibility was important as, due to its high level of debt issued under national law, Greece was not a typical case of debt restructuring.

- CACs were of key significance, though mainly because of their absence in Greek bonds. However, even where they did exist, they could not always resolve the holdout problem.

- For the first time, credit default swaps (CDS) played a significant role, as there was much uncertainty surrounding their effect and the behaviour of the creditors covered in the restructuring negotiations. A core problem was the fact that activating CDS was subject to a decision by one of the committees within the International Swaps and Derivatives Association (ISDA).

- It is unclear whether creditors' interests are adequately represented by the IIF.

3.7 Argentina's problem with holdouts

Holdouts are creditors who decide not to accept the debt restructuring deal and then subsequently seek legal action to assert their contractual rights. One of the main types of holdouts are what are known as "vulture funds", which purchase bonds at highly discounted prices during the crisis with a view to claiming redemption of their full face value in case of an insolvency. Until recently, the problem of holdouts – one of the main driving forces behind the SDRM – was generally perceived to be exaggerated.10 In the spring of 2013, however, the Court of Appeals in New York ruled in favour of holdout creditors asserting their rights from Argentine bonds issued prior to the 2001 state bankruptcy. This ruling was based on an interpretation of the pari passu clause, which is a standard element of most bond contracts, intended to

9 For the terms of reference of eurozone CACs, see:

http://europa.eu/efc/sub_committee/cac/cac_2012/index_en.htm

10 In the context of multilateral debt relief (HIPC/MDRI), however, there have been several cases in which private

investors claimed redemption and thus pushed up the cost of debt relief that was financed by official funds.

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guarantee that all creditors of the same class are treated equally. Over time, the pari passu clause came to be interpreted to refer to making proportionate payments to the holders of new bonds as well as holdouts. The New York court went one step further, forbidding Argentina to pay the holders of the exchanged bonds before settling the holdouts' claims, thereby forcing payment of the holdouts. This ruling could set a precedent for future holdout cases, making it far more interesting to hold out, and limiting the advantages of the flexible ad hoc approach used today. This would eliminate much of the incentive to accept debt restructuring deals. The case of Argentina also shows the lack of coordination between the different courts and jurisdictions. Independently of each other, courts in different jurisdictions and also the World Bank’s International Centre for Settlement of Investment Disputes (ICSID) handle cases brought by holders of Argentine bonds (cf. also Section 4.1.3 and Annex II). This international dispersion of court cases is particularly problematic in the context of equitable treatment of creditors. This, in turn, could well spur calls for a more reliable framework for sovereign debt restructuring.

3.8 Evaluating the current framework

The current framework for restructuring sovereign debt remains informal and based on voluntary ad hoc solutions. In regard to the restructuring of debt, recent resolutions of crises have not produced wholly satisfactory outcomes. Moreover, a range of new problems has surfaced. The question is, therefore, to what extent this framework could be enhanced.

As the case of Greece shows, the current ad hoc approach can accommodate special circumstances quite well. This has, however, not produced particularly satisfactory solutions. Restructurings tend to come late and place an excessive financial burden on the national and international official sector.

Regarding organisation and solution finding, the restructuring talks in the case of Greece were satisfactory. The fact that most of the debt was subject to domestic law facilitated considerably the solution. Similar types of solutions are, however, likely to be anticipated by creditors in the future and will therefore probably be excluded.

Eurozone CACs address the holdout problem and create the basis for coordination across different groups of creditors. It has not been proven, however, that CACs and aggregation clauses are sufficient for reaching a decision among creditors of different jurisdictions.

Debt relief of the poorest countries by official creditors was resolved quite satisfactorily with the current approach under the Paris Club. The international community will, however, have to ensure a renewed build-up of excessive debts is prevented.

The protection by a New York Court of Appeals of claims by holdouts of Argentine bond is likely to make creditors less willing to voluntarily accept debt restructuring deals. Given the protracted proceedings over many years, the question arises as to whether a final restructuring decision binding on all parties would not be advantageous.

There is no possibility of a debt moratorium to protect creditors from other creditors being paid out in full before a debt restructuring deal is concluded.

Fresh funds for crisis resolution generally come from official sources, which should therefore be excluded from the restructuring. However, there are no reliable mechanisms or incentives for a comparable mobilisation of private funds. This further complicates private sector involvement in crisis resolution.

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4 Reform proposals

The main current proposals for reforming the sovereign debt restructuring framework come from various sources within the official sector, civil society and the private sector. Essentially, these proposals can be divided into statutory approaches, which foresee some form of institutionalised jurisdiction, and contractual, market-based approaches, which provide for the incorporation of standardised clauses in debt contracts. There already exists a wide range of such proposals. However, there is very little international support at present for discussing holistic reform approaches. Against this backdrop, this chapter shows how, in the view of Switzerland, the work could progress in smaller, pragmatic steps. Switzerland closely follows the discussions in this respect and expresses its opinion where possible. Annex III recaps its main activities recently carried out on such issues.

4.1 Statutory approaches

The SDRM is the most advanced proposal to date for an insolvency procedure with supranational legal effect (cf. Section 3.4). Apart from the SDRM, there are various other statutory approaches based on the establishment of an internationally recognised court or committee or a common rule of law. The main difference between these approaches is the degree of jurisdiction sought.

4.1.1 Permanent courts

In 2009 a commission of UN experts proposed the establishment of an International Debt Restructuring Court (IDRC).11 The IDRC would ensure that debt restructurings are conducted in a manner that is efficient, equitable, transparent and timely. It would also create transparency on general borrowing and thus contribute to more efficient debt financing in general. The rules governing the IDRC would lay down the process for debt restructurings and define the IDRC's role in this. The IDRC would be based on an internationally recognised set of rules that defines the principles for specifying the priority of claims, determining the required debt reduction and distributing the burden fairly among creditors. As a permanent body, it would also contribute to defining standards related to debt restructuring. The main advantage of the IDRC, as with the SDRM, would be the ability to systematically involve the different classes of creditors (bonds of different issuances, private and official bilateral loans, etc.). Moreover, the IDRC would evaluate the legitimacy of debt claims and enable private and official creditors to extend new loans despite a default (so to as maintain important functions within the economy). The IDRC would find its legitimacy in worldwide recognition of its rulings by all national courts. However, given that states would have to concede some jurisdiction, the proposal for an IDRC is, at present, not likely to achieve global consensus. Proposals for a Sovereign Debt Tribunal (SDT)12 envisage the creation of a standing tribunal of arbitrators, which can be summoned in the case of disputes regarding sovereign insolvency. The SDT would be activated through arbitration clauses in bond contracts. In 11 United Nations (2009). Recommendations of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, A/63/838. (New York N.Y.: United Nations). http://www.un.org/ga/president/63/interactive/financialcrisis/PreliminaryReport210509.pdf12 Paulus, Cristoph (2010). A Standing Arbitral Tribunal as a Procedural Solution for Sovereign Debt Restructuring. In Braga, Carlos A. Primo and Gallina A. Vincelette (eds.), Sovereign Debt and the Financial Crisis: Will This Time Be Different?( Washington: World Bank Publishers). http://siteresources.worldbank.org/INTDEBTDEPT/Resources/468980-1238442914363/5969985-1295539401520/9780821384831_ch13.pdf

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other respects, no further adaptation of national regulations is required. The SDT would be established under the auspices of a globally recognised institution, such as the United Nations. The Secretary-General of the United Nations would then be responsible for appointing a pool of 10 to 20 arbitrators, from which creditors and debtors in the dispute would constitute the tribunal. The proposal does not define the reach of the SDT's competencies. As with the SDRM and the IDRC, it would, in principle, be possible to include all bonds and a broader body of creditors, particularly if these were also implicated contractually by an arbitration clause. As a standing tribunal, the SDT would systematically avoid disagreement on the convocation, structure and competencies of a court of arbitration. Furthermore, a standing tribunal should have greater influence on prevailing legal practices in debt restructuring than ad hoc courts or committees. However, an SDT would require the introduction of compatible arbitration clauses in bond contracts and other debt contracts.

4.1.2 Ad hoc courts of arbitration

The Fair and Transparent Arbitration Process (FTAP)13, championed mainly by NGOs, proposes an international insolvency procedure based on an ad hoc arbitration mechanism. The FTAP is activated by the debtor country. A debt moratorium may be called and capital controls imposed at the same time. The debtor country and its creditors each propose one or two arbitrators and then designate another one to chair the panel. The court's role is to verify debts and their legitimacy and to determine debt sustainability. All stakeholders affected by the debts are entitled to a public hearing. The court rules on the restructuring with a simple majority. The ad hoc nature of the FTAP makes it a more cost-efficient option than a permanent court. It would also allow for a holistic view of all debt types. The question is, however, whether an ad hoc court of arbitration has the capacities and the legitimacy to evaluate the sustainability and legality of the debt. It is also unclear whether such a procedure would be equally accepted by debtors and creditors, to enable enforcement of the arbitrational outcome.

4.1.3 Recourse to existing courts

The World Bank’s International Centre for Settlement of Investment Disputes (ICSID)14 is a permanent body with a mandate to resolve disputes in bilateral investment matters. It is based on the ICSID Convention for bilateral investment treaties (BITs) signed between individual countries. ICSID is one of the few international bodies that have dealt with legal disputes concerning the restructuring of sovereign bonds held by private investors. In the case Abaclat and Others v. Argentina – brought by a group of Italian holdout bondholders against Argentina (cf. Annex II) – sovereign bonds were recognised by ICSID as investments. This meant that ICSID had jurisdiction as a court of arbitration in this case, based on the bilateral investment treaty between Italy and Argentina. In principle, the idea that an existing internationally recognised arbitration body like ICSID would specialise in this area is an interesting one. However, given the wide variety of BITs around the world, this approach would likely be very difficult to implement. BITs are not standardised agreements between countries, as is clear from the different ways they treat sovereign bonds. Some BITs explicitly include sovereign bonds in the scope of investments. 13 Kaiser, J. (2010). Resolving Sovereign Debt Crises. Towards a Fair and Transparent International Insolvency Framework. Friedrich Ebert Stiftung Working Paper, September 2010. Raffer, Kunibert (2005). Considerations for Designing Sovereign Insolvency Procedures, Law, Social Justice & Global Development Journal. 14 https://icsid.worldbank.org/ICSID/Index.jsp

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Others explicitly exclude them, while still others make no reference at all to their treatment. Another problem is the fact that not all countries conclude BITs with each other, and some countries categorically refuse to enter into new BITs. Uniformity could be achieved under a multilateral investment treaty, as recently proposed. As yet, however, reform proposals towards a multilateral investment treaty do not seem to have sufficient support.

4.1.4 Consultation and information sharing platforms (with no jurisdiction)

The proposal for a Sovereign Debt Forum (SDF)15 envisages the creation of an informal standing body for consultation and information sharing between debtors, official and private creditors, international institutions and civil society. The forum would gather and disseminate information on debt restructuring. It would be purely informal in nature, with membership open to all relevant stakeholders. Where necessary, information would be treated discreetly so as to foster transparency between the parties. Voluntary stays of legal action by members form a key aspect of the forum, as they would provide the space needed to engage in talks. The SDF would make the restructuring of sovereign debt more predictable and speed up the process of finding a solution through enhanced communication and greater transparency between debtors and creditors. It is not yet clear how the SDF's operating costs would be financed; while these are likely to be minimal, a small permanent staff would still be required. A tax on bonds would not really be feasible, and incorporating the SDF into a creditor-independent multilateral institution seems unrealistic.

4.2 Contractual approaches

The set of tools used today for sovereign debt restructuring is considered a contractual approach, as the legal relationship between debtor and creditor is solely defined by the debt contracts. Restructuring is negotiated in an informal framework between the debtor country and creditor representatives. The solution usually involves exchanging existing securities for new securities. There is significant variety of contract types applicable to the various domestic and foreign bonds. Often the contractual basis for domestic issuances is relatively straightforward and standardised, while international issuances entail complex contracts16 that differ greatly from one jurisdiction to another. In principle, the bond documentation could be extended to form a framework that entails key statutory elements.

4.2.1 Collective action clauses

As described in Chapter 3, the latest reforms have focused on introducing partially standardised collective action clauses (CACs). In 2003, for example, the G10 published its model CACs, applicable to all bonds issued abroad and in foreign currency. The European Stability Mechanism (ESM) then introduced the eurozone CACs, as of 1 January 2013, for all eurozone countries. With CACs, certain contractual conditions can be modified through a qualified majority of

15 Gitlin and House (2013). A Renewed Proposal for a Sovereign Debt Forum. http://sauvescholars.org/uploads/A%20Renewed%20Proposal%20for%20a%20Sovereign%20Debt%20Forum%20-%2027Mar2013.pdf16 Small countries and emerging economies tend to seek debt on the international capital market, while larger

countries or those with a large domestic financial market (such as Switzerland) are mainly financed through their domestic capital market.

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creditors of a given issuance, generally 75% of the outstanding principal. This may be done as a pre-emptive or post-default measure. In the case of default, the creditors may vote to accelerate payment with, as a rule, 25% of the outstanding capital. In turn, this move may be reversed by a simple majority. In principle, this allows debt restructuring workouts to be conducted in a conclusive manner. This can, in particular, minimise the problem of holdout creditors. One of the main drawbacks with CACs is that, to date, they mainly only refer to individual issuances. As a country's debt profile normally consists of very many issuances as well as other debt types such as loans from official and private institutions, CACs alone are of limited use in restructurings. In other words, CACs are a necessary but by no means a sufficient basis for orderly debt restructuring.

4.2.2 Other contractual elements

Aggregation clauses may be added to CACs so that decisions taken by a qualified majority of creditors can also be applied to different bonds and different creditor classes. The aggregation clauses in eurozone CACs stipulate that the restructuring deal must be accepted by both a qualified majority (normally 75%) of the entire outstanding debt as well as a qualified majority (normally 66.6%) of each individual issuance. Aggregation clauses have previously been used by countries such as Uruguay, Argentina and the Dominican Republic. However, very little experience has been made to date with aggregation clauses, and their robustness is questionable, particularly concerning their legal effect in different jurisdictions. One key element of the G10 model CACs is a trust structure, whereby creditors are represented by a trustee. The trustee is assigned certain creditor rights, such as the right to terminate or to institute legal proceedings. This allows for a stay of legal action, providing additional time for reorganisation. Contact persons are also defined to supervise the issuances in question and to represent the creditors in negotiations. As trusts are primarily a feature of Anglo Saxon law, this element was not made binding in the eurozone CACs. Opinions differ as to whether the advantages of representation and supervision of the issuance are actually achieved in practice by the trust structure. The idea of a contact person responsible for the concerns of the creditors of a particular issuance could, however, contribute to a better representation of a highly diverse group of creditors in the future. A standstill clause could be used to introduce the possibility of a stay of legal action, thereby supporting a debt moratorium and thus giving time for negotiation. Disclosure obligations could also be further defined contractually. Finally, the bond contract could make reference to a governing instance or an arbitration body (cf. Section 4.1).

4.2.3 Standardisation of contractual elements

Given the increasing use of CACs, the fundamental question arises as to whether and to what extent the legal language for sovereign bonds could or should be standardised internationally. In theory, standardisation would rule out significant uncertainties and thus contribute to a better assessment of the risks associated with sovereign bonds. For example:

a) A voluntary international agreement on uniform contractual elements such as CACs or aggregation, standstill and information clauses. As with the G10 model CACs, standards could be established to be implemented and applied by participating states. This would establish principles for the development of an international standard.

b) A standardisation of certain contractual elements, particularly the majority thresholds for clearly defined contractual elements and aggregation. Here, as with the eurozone CACs, states would ensure the legal prerequisites for applicability of the

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contractual elements. c) A simple general contractual standard for sovereign bonds. Depending on the

form, this could offer the markets considerably more predictability. The extent to which this is binding would be a matter of negotiation.

The international institutions that could advance such work are, in particular, the IMF and the FSB. The G20 would, furthermore, play an important role in advancing this work.

4.3 Switzerland's position

It is clear from the above that there is no shortage of interesting proposals for reforming the framework for sovereign debt restructuring. An institutionalised approach may ideally seem the most effective choice; however, it would likely be extremely difficult to flesh out such a procedure in a realistic and acceptable manner. In the past, Switzerland has, in principle, advocated a statutory approach and, specifically, the formulation of an SDRM. At present there is, however, only scant support for resuming this discussion. The larger countries, in particular, are not prepared to even discuss holistic reform approaches within international bodies. For this reason, the Federal Council currently favours a more pragmatic approach. This is compatible with the technical discussions held within the IMF as well as other international fora. These discussions focus on contractual reform proposals, which have now gained support not least because of the introduction of eurozone CACs. In general, the Federal Council regards the increasing introduction of CACs as positive. Meanwhile, the statutory approaches should be regarded as important points of reference for longer-term reform of the international financial architecture, as these contain certain key elements that could, at least partially, be transferred to a contractual framework. The Federal Council believes that, in particular, the following elements of a statutory approach should be examined in the context of a contractual framework:

Systematic inclusion of different classes of creditors: A more widespread use and standardisation of CACs and aggregation clauses is currently the most realistic reform approach. In principle, these clauses allow for the restructuring of bonds of different issuances and could also be introduced in other debt contracts. It is not yet clear, however, whether aggregation clauses can be effective without an arbitrating body.

Arbitrating body: In principle, a body that can arbitrate between different creditors and types of debt would be useful, as this could lend further support to the functioning of CACs and aggregation clauses. Referral to an arbitration body would have to be settled by contract in advance. However, such a body could only be effective if a critical mass of contracts contained such references.

Debt moratorium: In principle, the possibility of a stay of legal action, so as to guarantee a debt moratorium, would be helpful. This would provide the time needed to produce an orderly and long-term solution. This possibility could be provided for contractually by means of a standstill clause; here too, however, a critical mass of contracts would have to include such a clause.

Within the relevant bodies such as the IMF, FSB, the Paris Club and the G20, Switzerland will call for an evaluation of the advantages of standardising the above contractual elements and examining the possibility of their introduction in sovereign bond contracts. Switzerland will also address this in bilateral meetings and make its position clear in the discussions in related bodies such as the World Bank, Regional Development Banks and UN-Agencies.

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Bonds issued by the Swiss Confederation currently do not contain CACs. If the standardisation of CACs were to gain favour in the international community, advice would have to be sought on the possibility of amending the Swiss Code of Obligations. In principle, Swiss law does refer to the reorganisation of bonds (Art. 1157 ff. CO: Community of Bond Creditors), although, according to Art. 1157 (3) CO, this does not apply to bonds issued by the Confederation. It is, however, possible for other countries to issue, in Switzerland, bonds that contain CACs (e.g. eurozone CACs, G10 type).

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5 Conclusions

This report shows that the absence of a robust framework for restructuring sovereign debt represents a gap in the international financial architecture. Debt restructurings have often been too little and too late, increasing the financial burden on the official sector. A predictable framework for restructuring sovereign debt would be an important component of credible crisis resolution effort. It would also contribute to better risk assessments by the markets and thereby a more effective approach to crisis prevention. The Federal Council therefore believes it is important for Switzerland to continue promoting the creation of a more robust framework for restructuring sovereign debt. A more predictable international procedure would be in Switzerland's own interest, as this contributes to strengthening the stability and openness of its financial centre. Switzerland will, as in the past, continue to support reforms for a more systematic involvement of different creditors in crisis resolution. This should be particularly relevant in the work of the IMF, the FSB, the Paris Club and the G20 as well as in bilateral meetings and in working groups. Switzerland will also address these issues in the discussions in related bodies such as the World Bank, Regional Development Banks and UN-Agencies. The corresponding proposals will mainly concern possible international agreements on adapting sovereign bond contracts. The Federal Council believes it is important to place this work within the general context of international financial architecture reforms, something that Switzerland will emphasise in international discussions. In this respect, the Federal Council wishes to stress the following points: Debt restructuring – as a solution of last resort – must find acceptance. International

commitment to creating a framework for orderly procedures would be an important step in this direction.

A more robust framework for restructuring sovereign debt calls for consistent implementation of international financial sector reforms. This includes legislation to eliminate the "too big to fail" problem in the banking sector, improve transparency in accounting for risks, and set the basis for resolving systemic financial institutions.

There should be limits on official funds made available for crisis resolution. Without such limits, the distortion in favour of excessive bailouts will continue to exist. In particular, clearer limits on access to IMF funding are likely to be need.

The Federal Council sees the greatest need for action in advancing contractually based mechanisms that allow for a more consistent inclusion of different creditors in the restructuring of sovereign debt.

The Federal Council regards contractual refinements such as the introduction and standardisation of CACs and aggregation clauses as important steps. If the standardisation of CACs were to gain support among the international community, an amendment to the Swiss Code of Obligations would need to be examined.

Furthermore, the Federal Council believes that the following contractual elements would contribute to making the framework for restructuring sovereign debt more robust:

A contractually anchored arbitrating body should help to ensure coordination of claims within a reasonable timeframe and the equal treatment of creditors.

A contractually anchored debt moratorium would be conducive to timely action. Switzerland will advance these points in the international discussions.

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Figures

Figure 2.1: Global debt developments since 1920 ................................................................... 7 Figure 2.2: Debt-to-GDP rates of selected countries in 1960, 1980, 2000 and 2012 ............... 8

Abbreviations

AfDB African Development Bank BIT Bilateral investment treaty CACs Collective action clauses CDS Credit default swap ECB European Central Bank EFSF European Financial Stability Facility ESM European Stability Mechanism FSB Financial Stability Board FTAP Fair and Transparent Arbitration Process GDP Gross domestic product HIPC Heavily Indebted Poor Countries Initiative ICSID International Centre for Settlement of Investment Disputes IDRC International Debt Restructuring Court IFA International financial architecture IIF Institute of International Finance IMF International Monetary Fund IMFC International Monetary and Financial Committee ISDA International Swaps and Derivatives Association MDGs Millennium Development Goals MDRI Multilateral Debt Relief Initiative OECD Organisation for Economic Co-operation and Development SDDRF Sovereign Debt Dispute Resolution Forum SDF Sovereign Debt Forum SDRM Sovereign Debt Restructuring Mechanism SDT Sovereign Debt Tribunal UNCTAD United Nations Conference on Trade and Development

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Further reading

Bingham, G. (2012). The Bankruptcy of Bankruptcy. In Fuchita Y., Herring R. and Litan R. (eds.) Rocky Times: New Perspectives on Financial Stability. Brookings Institution Press. November 2012. Committeri, M. & Spadafora, F. (2013). You Never Give Me Your Money? Sovereign Debt Crises, Collective Action Problems, and IMF Lending. IMF Working Paper WP/13/20, January 2013. http://www.imf.org/external/pubs/ft/wp/2013/wp1320.pdf Das, U., Papaioannou, G. & Trebesch, C. (2012). Sovereign Debt Restructurings 1950-2010: Literature Survey, Data, and Stylized Facts. IMF Working Paper WP/12/203, August 2012. http://www.un.org/esa/ffd/ecosoc/debt/2013/IMF_wp12_203.pdf Economic and Financial Committee (2012). Common Terms of Reference for the Eurozone- CACs. http://europa.eu/efc/sub_committee/pdf/cac_-_text_model_cac.pdf Gelpern, A. (2013). Sovereign Damage Control. Peterson Institute for International Economics Policy Brief No. PB13-12, May 2013. http://www.iie.com/publications/pb/pb13-12.pdf Gianviti, F. , Krueger, A., Pisani-Ferry, J., Sapir, A. & von Hagen, J. (2010) A European Mechanism for Sovereign Debt Crisis Resolution: A Proposal. Bruegel Blueprint 10.

Brussels.http://www.bruegel.org/download/parent/446-a-european-mechanism-for-sovereign-debt-crisis-resolution-a-proposal/file/928-a-european-mechanism-for-sovereign-debt-crisis-resolution-a-proposal-english/

Group of Ten (1996). The Resolution of Sovereign Liquidity Crises: A Report to the Ministers and Governors Prepared under the Auspices of the Deputies. Washington, D.C. http://www.bis.org/publ/gten03.pdf Group of Ten (2003). Report of the G-10 Working Group on Contractual Clauses. Washington, D.C. http://www.bis.org/publ/gten03.pdf Hagan, S. (2005). Designing a Legal Framework to Restructure Sovereign Debt. Georgetown Journal of International Law, 36(2): 299-403. IEO (2004). Evaluation Report: The IMF and Argentina 1991 – 2001. Washington, D.C., July 2004. http://www.ieo-imf.org/ieo/files/completedevaluations/07292004report.pdf IIF (2012). Report of the Principles Consultative Group on 2012 Implementation of the Principles for Stable Capital Flows and Fair Debt Restructuring. October 2012.

http://www.iif.com/download.php?id=mUq/5udGdME= IMF (2001a). Involving the Private Sector in the Resolution of Financial Crises – Restructuring International Sovereign Bonds. January 2001.

http://www.imf.org/external/pubs/ft/series/03/ IMF (2001b). A New Approach to Sovereign Debt Restructuring: Preliminary Considerations. November 2001. http://www.imf.org/external/np/pdr/sdrm/2001/113001.pdf IMF (2002a). Sovereign Debt Restructuring Mechanism – Further Considerations. August 2002. http://www.imf.org/External/np/pdr/sdrm/2002/081402.htm

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IMF (2002b). The Design of the Sovereign Debt Restructuring Mechanism. November 2002. http://www.imf.org/external/np/pdr/sdrm/2002/112702.htm IMF (2003a). Crisis Resolution in the Context of Sovereign Debt Restructurings. January 2003. http://www.imf.org/external/np/pdr/sdrm/2003/012803.htm IMF (2003b). Proposed Features of a Sovereign Debt Restructuring Mechanism. February 2003. http://www.imf.org/external/np/pdr/sdrm/2003/021203.htm IMF (2003c). Report of the Managing Director to the International Monetary and Financial Committee on the IMF's Policy Agenda. April 2003.

http://www.imf.org/external/np/omd/2003/041103.pdf IMF (2003). Reviewing the Process for Sovereign Debt Restructuring Within the Existing Legal Framework. August 2003. http://www.imf.org/external/np/pdr/sdrm/2003/080103.htm IMF (2013). Sovereign Debt Restructuring: Recent Developments and Implications for the Fund's Legal and Policy Framework, April 2013. http://www.imf.org/external/np/pp/eng/2013/042613.pdf Kaiser, J. (2010). Resolving Sovereign Debt Crises. Towards a Fair and Transparent International Insolvency Framework. Friedrich Ebert Stiftung Working Paper, September 2010. Krueger, A. (2001). International Financial Architecture for 2002: A New Approach to Sovereign Debt Restructuring. Address given at the National Economists' Club Annual Members' Dinner, Washington, D.C., November 2001.

http://www.imf.org/external/np/speeches/2001/112601.HTM Panizza, U., Sturzenegger, F. & Zettelmeyer, J. (2009). The Economics and Law of Sovereign Debt and Default. Journal of Economic Literature, 47(3): 1-47. Raffer, Kunibert (2005). Considerations for Designing Sovereign Insolvency Procedures. Law, Social Justice & Global Development Journal.

http://www.go.warwick.ac.uk/elj/lgd/2005_1/raffer Reinhart, C. & Rogoff, K. (2009). This Time is Different. Princeton University Press. Schadler, S. (2012). Sovereign Debtors in Distress: Are our Institutions up to the Challenge? Cigi Papers No. 6, August 2012. http://www.cigionline.org/sites/default/files/no.6.pdf Weidemaier, W. & Gulati, M. (2012). A People's History of Collective Action Clauses. UNC Legal Studies Research Paper No. 2172302.

http://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=5387&context=faculty_scholarship

Wright, M. (2012). Sovereign Debt Restructuring: Problems and Prospects. Harvard Business Law Review, 2(1): 153-197. Zettelmeyer, J, Trebesch, C. & Gulati, M. (2013). The Greek Debt Restructuring: An Autopsy. July 17, 2013. SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2144932

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Annex I: Case studies

The following case studies should help illustrate the process of restructuring sovereign debt and describe the roles the private and official sectors can play.

Case 1: Argentina

Prior events Exacerbated by a worsening economic situation since 1998, Argentina's sovereign debt woes culminated in a default on both its domestic (November 2001) and external (December 2001/January 2002) debt. The main contributing factors were:

- Although Argentina's currency board fixed to the US dollar since 1992 had kept inflation at bay, the dollar's continual appreciation increasingly weighed on economic output (recession from 1998) and ultimately led to deflation.

- Lax fiscal discipline and politically motivated spending were, over many years, financed by external debt denominated in foreign currency. This subsequently limited the scope for economic policy.

- A series of external shocks, particularly the crises in Russia and Asia, weakened global economic conditions. Argentina was further impacted by neighbouring Brazil's currency devaluation.

Waning confidence in the currency board led to massive capital outflows abroad from October 2001. By December 2001, the government imposed a domestic deposit freeze. Meanwhile, refinancing costs soared. The currency board was abandoned in January 2002. The IMF initially supported Argentina's crisis measures but, as it became clear that no major changes were being implemented, the exceptional financing program was suspended in December 2001. Despite its – by today's standards – relatively low government debt (62.2% of GDP in 2001) and low external debt (52.2% of GDP in 2001), Argentina defaulted on its entire public debt in December 2001 and January 2002 respectively. Debt restructuring Domestic debt was restructured relatively quickly, with the state grandly encouraging or, to a certain extent, obliging businesses, banks and retail investors to buy new government bonds and exchange existing bonds. The renegotiation of external debt was a drawn-out process, however, with talks only beginning in March 2003. It then took another two years before creditors were offered a restructuring deal, completed shortly thereafter in February 2005. Argentina's default was then the largest in history, estimated at USD 100 billion. The debt reduction was also high at an estimated 75% of face value.17 The more than 152 different bonds were exchanged for three new types of bonds (par, quasi-par and discount bonds, i.e. carrying either a lower face value or a lower coupon), and interest was linked to future GDP growth. In addition, all new bond issuances incorporated CACs. The makeup of the private creditors was highly fragmented: while over half of bonds were held by institutional investors, there were more than 600,000 retail investors (of whom around 450,000 were in Italy, 35,000 in Japan and 150,000 in Germany or Central Europe); some of these had invested a large portion of their savings. Apart from Argentine holders of external sovereign bonds (38.4%), European institutional investors were also affected (Italy 15.6%, Switzerland 10.3%, Germany 5.1%), followed by US (9.1%) and Japanese bondholders (3.1%). The creditors joined forces to better defend their interests, resulting in

17 The amount of the haircut varies according to the discount rate. A 10% discount rate is assumed here.

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the formation of the Global Committee of Argentine Bondholders (GCAB) in December 2003, which represented some 50% of Argentina's debt. Participants, especially retail investors, did not find the negotiations to be constructive. The absence of a formal negotiation procedure and clearly defined deadlines proved a problem. Although meetings were held on an occasional basis, these produced no substantial progress. Argentina's negotiating position was further weakened by the absence of a minimum quorum and of exit consent clauses for the exchange offer. In general, the creditors were critical of the government's policy prior to the crisis, which had prevented it from taking the necessary reforms in good time. A report published in 2005 by the IMF's Independent Evaluation Office points to the failure to systematically address many deficiencies that were already known years beforehand.18 In this context, IMF loans prior to the crisis and as it evolved had actually contributed to further delays in the reforms needed. The overall participation rate in the restructuring process, completed in April 2005, was quite low at 76.2% of the total outstanding amounts. Holders of bonds with a face value of some USD 25 billion rejected the proposal in the hope of recuperating their entire nominal value. This was despite Argentina's introduction of a most favoured creditor clause in the new bonds, guaranteeing that holdouts would not be offered a better deal in the future. It would subsequently emerge, however, that this clause could not close the door open to litigation. Consequences – holdouts Argentina is still in confrontation with holdout creditors seeking to recuperate the original nominal value through litigation. These include so-called vulture funds, which bought up bonds at a discount during the crisis specifically so as to claim, in case of a default, redemption of the entire face value. In September 2006, the Italian investor group "Task Force Argentina" contested the restructuring (Abaclat and Others v. Argentina) on the grounds that it contravened the bilateral investment treaty (BIT) signed between Argentina and Italy in 1990 to protect investors against discrimination and expropriation. Over 180,000 bondholders lodged a class-action lawsuit with the International Centre for Settlement of Investment Disputes (ICSID), which agreed to defend the case in August 2011 in recognising the Argentine bonds as investments and thus subject to the BIT. The case is currently suspended. The ICSID's competence in such matters remains a matter of dispute. While ICSID was still examining its competence in the Italian class-action suit, Argentina made the remaining holdouts a new exchange offer in 2010, despite having ruled out in 2005 the possibility of further offers and payments on better terms. Around 120,000 of the Italian plaintiffs accepted this second offer, leaving some 60,000 plaintiffs still referring to the BIT. Also claiming full redemption of the debt are some specialised hedge funds that had acquired bonds cheaply from creditors unwilling to face litigation after Argentina's default. The most famous of these is Elliott Capital, which has made several attempts to force payment by seizing Argentine assets abroad, notably a training ship owned by the Argentine Navy. This was unsuccessful, however, as a result of the sovereign immunity enjoyed by such assets. In November 2012, Elliott Capital had its first success in a New York court case: based on the pari passu clause, the judge ruled that Argentina could not service its restructured debt before repaying Elliott Capital in full (face value of USD 1.3 billion plus accumulated interest). The pari passu clause, which forms part of most official debt contracts, seeks to guarantee equal treatment of creditors in the same category. The court ruled that the pari passu clause includes proportionate payments and, on this basis, the debts of new creditors and holdouts

18 Cf. http://www.ieo-imf.org/ieo/pages/CompletedEvaluation121.aspx

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should be serviced simultaneously and the latter in full. Argentina lodged an appeal, indicating its unwillingness to pay the holdouts, despite the threat this raised of defaulting on the new bonds. With default approaching, the court agreed to extend the deadline of 15 December 2012. The Court of Appeals in New York held a second hearing and, on 1 March 2013, ordered Argentina to submit a payment proposal for old and new bonds within four weeks. On 29 March, Argentina offered the same terms for the old bonds as in the 2010 debt exchange, a proposal rejected by Elliott Capital. The case is still pending but is now expected to be brought before the US Supreme Court. A ruling in this case could have major implications for future sovereign debt restructurings.

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Case 2: St. Kitts and Nevis

Prior events St. Kitts and Nevis was already heavily indebted before the global financial crisis (188% of GDP in 2006). After losing preferential access under the EU's sugar and banana protocols, the country came to rely increasingly on tourism, a sector that collapsed with the financial crisis of 2008-2009. Rising international food and energy prices had an adverse effect on its current account and trade balance, and a hurricane severely impacted its infrastructure, particularly in the tourism sector. Membership of the East Caribbean Currency Union (ECCU) restricted the government's scope for economic policy measures. When public revenues dropped by a further 13.5% in 2010, the deficit rose to 9.4% of GDP and debt soared to almost 200% of GDP, leading the government to seek IMF support. A three-year reform programme with a loan of some USD 80 million was agreed with the IMF. On this basis, St. Kitts and Nevis spelled out a path for restoring its public finances, strengthening its financial sector and restructuring its sovereign debt. Debt restructuring The restructuring of sovereign debt proceeded relatively quickly and smoothly. In June 2011, the government of St. Kitts and Nevis announced its intention to initiate restructuring talks. Of the overall debt of USD 1.1 billion, short-term Treasury Bills and debt to multilateral institutions (85% of which was held by the Caribbean Development Bank (CDB), 15% by other international financial institutions) were excluded, leaving bonds with an overall face value of USD 750 billion subject to debt restructuring. A distinction was made between the restructuring of (1) general external commercial debt (around 15.6% of total public debt, of which USD 135 million was to be restructured), (2) bilateral debt held by official creditors (approx. 2.7%) and (3) domestic debt (approx. 54.6%). The restructuring of external debt held by private creditors began with a government debt exchange offer on 27 February 2012. As early as 7 March 2012 a committee of bondholders representing a significant proportion of the debt indicated its intention to accept the offer. The process was successfully completed on 18 April 2012, with a high 97% of creditors participating. All domestically issued sovereign bonds incorporated CACs. As the 85% threshold for activating the CACs was met, the remaining 3% of creditors were bound to participate. The debt exchange deal gave creditors the option of exchanging their instruments for (1) EC$ par bonds with the same face value and a maturity of 45 years, carrying a 1.5% coupon, but with a 15-year grace period for redemption of the principal, or (2) USD discount bonds with a 50% upfront reduction in face value, with a maturity of 20 years and a coupon of 6% for the first four years, falling to 3% a year thereafter, backed by a partial guarantee from the CDB, with a claw back provision.19 Two-thirds of creditors (including the holdouts) opted for the second variant. The restructuring of bilateral debt held by official creditors was, for the most part, negotiated in the Paris Club. In May 2012, after six rounds of negotiations, the debt (including arrears) owed to Paris Club creditors by St. Kitts and Nevis was restructured over a 20-year period. A seven-year grace period on principal repayments and concessional rates of interest were also granted. The bulk of the debt relief came from individual countries. The UK, for example, chose to cancel the entire debt, while the US granted reduced interest rates. These measures correspond to a 60% debt reduction. As the bulk of domestic debt (some USD 600 million) had been held by domestic banks, it

19 Under the clawback provision, the creditors can claim further par bonds as compensation if St. Kitts and Nevis

fails to meet the steps agreed for the sixth review of the IMF programme.

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was particularly important to minimise the destabilising impact of debt restructuring on the financial sector. A debt/land swap was organised between the government and local banks, whereby land was assigned to a special purpose vehicle (SPV) in the form of a land asset management company. In turn, the SPV is mandated to sell the land and then use the proceeds to service the debt of domestic creditors. Given the large number of plots of land to be sold, the sales process will continue for several years to come. Once all debts have been settled, the remaining plots will be returned to the state.

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Case 3: Greece

Prior events Greece's financial difficulties came to a head in 2010, forcing the country to seek financial support from the EU and the IMF several times. A lack of fiscal discipline had resulted in an unsustainable level of accumulated debt and high budgetary deficits. In addition, the Greek economy suffered from poor competitiveness, a situation that could not be resolved through devaluation on account of its eurozone membership. In return for financial assistance, Greece agreed to cut its spending and to introduce structural reforms. After the original package of EUR 110 billion on 2 May 2010, a second rescue package was approved for Greece on 21 July 2011, though this one required the participation of private creditors. Banks that had joined forces with other creditors in the "Task Force for Greece", coordinated by the Institute of International Finance (IIF), subsequently approved a 21% reduction on the debt owed to them. Already by the time of the EU summit of 26/27 October 2011, however, after several rounds of negotiation and a further deterioration of the situation, EU Member States forced private creditors to accept a significantly higher haircut of 50% as a prerequisite for a new EUR 130 billion package. The IIF and the eurozone heads of state and government launched the debt restructuring process in the margins of the summit. Debt restructuring On 17 November 2011, the IIF Task Force for Greece transformed itself into a formal committee of private creditors, which comprised 32 members (mainly financial institutions), accounting for a large share (30-40%) of privately held Greek debt. The 32 creditors elected a Steering Committee of 13 major creditors, who conducted the formal negotiations with Greece from November 2011 to February 2012. As a result of bonds purchased under the Securities Market Programme (SMP), the ECB was the largest holder of Greek sovereign bonds (with EUR 56.7 billion, or 22%). However, a reduction in Greece's debt owed to the ECB would equate to an inadmissible financing of sovereign debt. Therefore, on 17 February 2012, the ECB's stock in Greek sovereign bonds was exchanged for equivalent new Greek bonds (same face value and same structure). The new sovereign bonds were exempt from the impending restructuring. With a total of EUR 206 billion in debt, this was at the time the largest ever restructuring of privately held sovereign debt. 91% of bonds were issued under Greek law, while the remainder were issued under the laws of other countries. As the bonds issued under Greek law did not contain collective action clauses (CACs), it was not possible to force 100% acceptance of the exchange deal. The deal was nonetheless well received, with a high participation rate, and helped to avoid a destabilising default. On 21 February 2012, Greece gave its creditors two weeks to accept or reject a restructuring deal. This was to be carried out with the participation of at least 90% of creditors. Furthermore, the EFSF had secured co-financing of EUR 30 billion for this case. The matter had to be resolved quickly as EUR 15 billion in debt was coming due in March 2012. The creditors were thus given very little freedom of choice, and only one offer was made. The deal was to exchange old bonds for a combination of new bonds with the following characteristics:

- One to two-year EFSF notes at 15% of the old face value. - 31.5% of the old face value in the form of sovereign bonds with a maturity of up to 30

years and coupons between 2% and 4.3%. - Issued under English Law and thus containing CACs. - GDP-linked securities offering up to 1% of the principal once a certain GDP threshold

is exceeded.

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On average, the restructuring resulted in a 53.5% debt reduction (more than the 50% agreed on in October 2011). Individually, however, the actual haircuts varied greatly, depending on the maturity. In addition, the extent of the haircut depends to a large extent on the assumed discounts. According to one commonly quoted calculation, holders of short-term bonds lost 80% through the restructuring, while holders of long-term bonds incurred hardly any loss in value. Of particular importance is the retrospective introduction of CACs in all Greek sovereign bonds, a fundamental condition of the restructuring deal. These CACs were formulated on the basis of the eurozone CACs subsequently introduced (on 1 January 2013). In order to prevent this being deemed equivalent to expropriation and contested by the creditors, Greece enacted a law on 23 February 2012 that allowed it to impose a retrospective introduction of CACs with a 50% majority of all bondholders and a two-thirds majority of votes. The acceptance rate for the restructuring package was a high 96.9%, explained by the fact that the new bonds were de facto ranked higher than those not exchanged, making participation in the debt restructuring particularly attractive. Even the holdouts' bonds were given CACs without their approval. Any creditors willing to enter into litigation thus lost the advantages of not having CACs that could have offset the disadvantages of a de facto subordination of their debt claims. In addition to such sweeteners offered to bondholders to accept the restructuring deal, pressure on banks and financial institutions from their own countries' governments also likely played a role. Those financial institutions holding the most Greek bonds were in eurozone countries that were Greece's official creditors. They therefore had an interest in a swift resolution. Consequences The restructuring helped Greece make a sizeable reduction in its debt burden. With a haircut of EUR 106 billion (around 50% of GDP), the debt burden was reduced from 165.3% (end-2011) to 132.4% of GDP in March 2012. In addition, Greece also received significant interest concessions worth some EUR 30 billion. The restructuring quickly improved Greece's credit stance, with Standard & Poor's raising its credit rating from "selective default" (SD) to "CCC" already by 2 May 2012. Nonetheless, this debt restructuring was not sufficient to ensure the sustainability of Greece's debt. As a condition for another tranche of the financial rescue package, Greece had to agree in November 2012 to conduct a voluntary buyback programme with private bondholders. This concerns the some EUR 63 billion in debt that is still in private hands.

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Annex II: Collective action clauses

Eurozone CACs

Prior to the eurozone sovereign debt crisis, very few advanced countries apart from the UK used CACs in their government bonds. This was mainly due to the fact that most European countries issue their bonds under their own national laws. On 28 November 2010, the eurozone countries agreed to introduce standardised CACs within the framework of the European Stability Mechanism (ESM). The corresponding model collective action clauses were formulated by a sub-committee of the European Economic and Financial Committee. The ESM Treaty, which came into effect on 8 October 2012, requires the inclusion, as of 1 January 2013, of CACs in all new issuances of eurozone government bonds with a maturity of over one year. The eurozone CACs define the majority voting thresholds to bind all remaining bondholders to collective action. Amending key terms of bond issuances requires 75% approval on the first vote, while, if the meeting is adjourned, support is necessary from bondholders representing two-thirds of the outstanding principal. For less crucial decisions, however, the required approval threshold is 50% of the outstanding capital on the first vote or, where the voting is adjourned, 25% is sufficient. The simultaneous modification of the terms of one or more series of bonds may be required ("cross-series modification") where a series of bonds refers to the grouping of similar bonds (same terms, except for the issue date). Modification requires a 75% majority of the aggregated outstanding principal and a two-thirds' majority of the outstanding principal of each separate series. Bondholders are often given various alternatives in relation to cross-series modification, maximising their flexibility in the actual debt restructuring process. The eurozone CACs also include acceleration clauses, providing for a majority of bondholders to demand the immediate and complete reimbursement of interest and principal post-default. This is possible with a 25% majority of the outstanding principal. Accelerated payment can be reversed with the approval of 50% of the outstanding principal. Unlike the proposal for G10 CACs (see below), the eurozone CACs do not provide for the possibility of a stay on litigation. A bondholder representative is not automatically appointed, and sovereign bondholders and central banks retain their voting rights. The eurozone conditions are less strict because, otherwise, the new CACs could not have been reconciled with national legal practice. Since January 2013, the eurozone countries have been issuing government bonds with CACs. An initial assessment of the impact of CACs on states' refinancing costs will be made in a report to be published by the European Economic and Financial Committee on implementation of the new CAC standards.

G10 CACs

The G10 established a working group in June 2002 to develop model collective action clauses that would alleviate the problem of holdouts. It was also supposed to foster dialogue, transparency and fairness between debtors and creditors. The recommendations published in a report20 in September 2002 can be summarised in the following points:

- A bondholder representative should be appointed for each bond to act as an interlocutor between debtors and creditors. The issuing country is required to provide

20 Cf. http://www.bis.org/publ/gten08.htm#pgtop.

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greater transparency on the budgetary and economic situation. - As is the case under English Law, any amendment of reserved matters21 requires a

75% majority of the bondholders present at an ordinary meeting. However, a quorum of creditors representing at least 75% of the principal is required in order to hold an ordinary meeting. In the case of an adjourned meeting (if the first meeting failed to obtain the requisite quorum), the majority threshold is lower.

- In the case of non-reserved matters, a two-thirds majority of either the outstanding capital or the bondholders present at a meeting is proposed.

- A supermajority of bondholders that meets the required threshold for amending reserved matters should be able to vote for a stay on legal action (standstill). This gives the issuing country time to conduct its restructuring and crisis resolution in an orderly manner.

- Acceleration of payments post-default requires the support of 25% of bondholders. Such acceleration may be stopped by a two-thirds majority of the outstanding principal.

- Bonds held by state or quasi-state entities lose their voting rights and are not included when calculating the outstanding capital (disenfranchisement provision).

The G10 model clauses influenced the formulation of CACs in many countries, with deviations existing for certain majority rules or other terms regarding bondholder representatives (trustees).

21 As a rule, all payment terms are classified as reserved matters.

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Annex III: Activities undertaken by Switzerland in relation to the postulate

Within the main bodies responsible for the international financial architecture, Switzerland emphasises the need to improve the sovereign debt restructuring framework. It also raises the issue in bilateral meetings at both a ministerial and technical level. The main financial bodies are:

- International Monetary Fund (International Monetary and Financial Committee (IMFC), Executive Board)

- Financial Stability Board

- G20 Finance Track (meeting of finance ministers and central bank governors,

meeting of deputies, working groups)

- Paris Club The FDF, responsible for sovereign insolvency matters, participated in the following events in 2012 and 2013:

- Conference "A Debt Restructuring Mechanism for European Sovereigns – Do We Need a Legal Procedure?" Berlin, 13-14 January 2012

- Round Table on State Insolvency, Frankfurt, 15-16 March 2012

- Meeting of G4 Deputies, Paris, 2 April 2012

- Expert Group Meeting on Sovereign Debt Restructuring of the FfDO/UNDESA and

CIGI in New York, 18 May 2012

- Meeting with NGOs in Bern, 25 June 2012

- Meeting of G4 Experts, Zurich, 2 July 2012

- Expert Group Meeting on Sovereign Debt Restructuring of the FfDO/UNDESA and CIGI in London, 19 September 2012

- Expert Meeting "New Developments in Sovereign Debt Restructuring" of the IDB and

the FfDO/UNDESA, Washington, 16 April 2013