Inside the Black Box: How Should a Sovereign Bankruptcy Regime be Structured?

Abstract

the Institute of International Finance (llF) has complained."[A]t a time of extreme risk-aversion in emerging markets, when capital flows are falling ... approaches such as [the IMF plan] add further to uncertainty and investor anxiety.,,4 The hostility reflected in statements like this is based in part on principle and in part on obvious self-interest.The principled objection to sovereign bankruptcy is the risk that an SDRM will make it too easy for sovereign debtors to default.Much as bailouts create moral hazard on the part of creditors, sovereign bankruptcy could have a similar effect• on debWrs;-Limiting sovereign debtors' ability to restructure, on this view, encourages sovereigns to repay what they owe.The less principled explanation for the.underwriters' and investors' opposition is simply that the existing bailout app roach often assures that bondholders will be made whole.If an SDRM replaced bailouts as the strategy of choice, sovereign debt holders could no longer count on a handout when sovereigns encountered financial distress.Rather than either sovereign bankruptcy or the status quo, some observers, including the U.S. Treasury, have advocated still another, intermediate strategy for addressing sovereign financial distress: sovereign debtors, they argne, could use collective action provisions (also referred to as "CACs" or "majority voting provisions") to restructure sovereign debt.' CAC provisions authorize a specified majority, often seventy-five percent, of the holders of an issuance of bonds to agree to restructure the bond's payment or timing terms.Sovereign debt issued under U.K. law, which currently constitutes roughly forty percent of sovereign debt, already includes these provisions, but until recently New York bonds did not: Collective action enthusiasts argne that, if CACs were included in all sovereign debt, these provisions would provide a simpler and less intrusive way to restructure sovereign debt if necessary.Skeptics, on the other hand, have pointed out that collective action provisions 4 Michael M. Phillips, Bush Clears Way for Treaty Thar Eases Bankruptcies for Developing Nations� WALL ST. 1. EuR., Sept. 17,200 2, at A2 (quoting Charles Dallara and describing the Ill' as "the research ann of 325 financial institutions and investors »).5 For a fascinating and ambitious account of the benefits of collective action provisions, see Lee C.

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