In 2013, the Centre de droit international (CEDIN) of the University Paris Ouest – Nanterre La Défense (France) began a research project aiming at conceiving the legal engineering necessary for State insolvency proceedings. This report presents the conclusions reached by the research group.
The objective is to establish an international institution specially tasked with conducting insolvency proceedings involving a State experiencing financial distress: the International Centre for the Financial Safeguard of States (ICeFSS).
It is proposed that such a Centre be created through an international multilateral convention. A draft text of such a convention is proposed in the present report. Concerning its working methods, the settlement of a State’s insolvency submitted to the Centre would be the object of a conciliation procedure. In case the latter fails, arbitration proceedings would ensue. This report also includes a draft text of the rules for the conciliation and arbitration procedures.
These drafts aim at proposing feasible legal solutions for future sovereign debt crises that some States might experience. These solutions lie within an economic (I) and legal (II) framework to which they purport to provide new and appropriate responses.
The economic context for which these proposals are meant is the one marked by sovereign debt crises. Such crises regularly affect numerous States throughout the globe.
Sovereign debt is currently an essential trait of the global financial system. It concerns all groups of States, least developed as well as most developed, isolated or well integrated in monetary unions. The risk of default by several States on their debts, i.e., the non-payment of the capital borrowed when it becomes due or even the non-payment of interests, is considered as one of the most significant geopolitical and economic problems. It is a source of systemic crises and destabilisation for the global economy.
It must be noted that the composition of such debt has evolved since the 1970-1980s. In that period, sovereign debt was mostly made up of bank loans, i.e., loans privately negotiated between States and large private banking institutions. However, starting from 1990s, a major change has taken place. Bonds have become widespread. Bank loans thus represent a negligible portion of sovereign debt.
Such bonds entail two significant peculiarities:
- They had the effect of multiplying creditors and of diversifying the creditor’s community in nature and geographical location.
Creditors can now be not only private banks, but also investment funds, hedge funds, sovereign wealth funds or central banks, pension funds, or even private individuals.
Furthermore, all these bondholders can be potentially located anywhere in the world.
- Bonds are traded on a secondary market. Their initial holders can pass them on to new holders, generally at a discount or a premium.
Undoubtedly, State debts being mainly made up of bonds represent a source of complexity for the settlement of insolvency situations that might affect the issuer State. The current legal framework hardly allows for a satisfactory legal response.
According to the nature of creditors or of claims, the settlement of the insolvency or, more generally, of payment difficulties of a State does not involve the same obstacles.
When the State debt towards public creditors is at stake, e.g., other States, the IMF, the World Bank or the European Union, the negotiation of a rescheduling or a write-down is relatively easy to organise. After all, these creditors are few and easily identifiable. Furthermore, the Paris Club was created to institutionally structure this kind of negotiations, if necessary.
With regard to the bank debt, i.e., loans made by banks, restructuring negotiations are also relatively easy to implement. Here again, creditors are well identified, as they are large private banking institutions. The London Club can, if need be, allow to institutionally structure the debates between them and the debtor State.
However, for the State bonded debt, the composition of the mass of creditors is diverse and huge. Therefore, it is much more difficult to establish an appropriate form of restructuring negotiations.
Consequently, when a State that issued bonds experiences problems in meeting its payment obligations, currently it only has two options:
- Unilaterally suspend its payments without consulting its creditors (as Argentina did in 2001);
- Restructure its debt by negotiating with its creditors (as Greece did in 2012).
In the latter case, today the trend is to insert collective action clauses (CACs) into the bond issuance contracts. Such clauses allow a qualified majority of creditors to agree on a restructuring proposed by the State, which becomes binding on all other holders of the same bond. Nevertheless, such a solution is arguably not fully satisfactory. After all, it entrusts the negotiation to the State and only a part of its creditors.
This is why an institutional solution aiming at finally establishing a real “international law on State insolvency proceedings” is definitely a relevant option to preserve the world’s economic and financial stability. To this end, in 2015 the General Assembly of the United Nations decided to create a multilateral legal framework for sovereign debt restructuring processes (see Resolutions 68/304 of 9 September 2014, and 69/247 of 29 December 2014).
Furthermore, in the past, the creation of institutional mechanisms aiming at tackling sovereign insolvency had already been proposed, and thereafter abandoned. Such was the case of the Tribunal under the auspices of the League of Nations in 1939 and of the Sovereign Debt Restructuring Mechanism (SDRM) under the aegis of the IMF in 2003.
The objective of the research programme initiated by the CEDIN (whose results and proposals are presented in this report) was to draw the lessons from these past experiences, and invent and propose an international mechanism to respond to the insolvency of State borrowers, taking into account the specificities of the bond market.
For the present project, a Working Group of academics and practitioners has been established within the CEDIN. The objective is to propose an institutional mechanism to organise and structure the insolvency of a State. The two guiding principles are:
- Respecting the equality of treatment among creditors;
- Maintaining a sustainable financial situation for the debtor State, that would allow its economy to recover.
At the end of its work and discussions, the Working Group identified and determined an institutional mechanism for State insolvency proceedings. Its main characteristics are as follows:
- Legal nature: a dedicated international organisation created by an international multilateral convention, for which a draft text is proposed in the present report. It is suggested to denominate this institution the International Centre for the Financial Safeguard of States (ICeFSS).
However, the option of an existing international organisation hosting this new institution is not at all ruled out. The link between the International Centre for Settlement of Investment Disputes (ICSID) and the World Bank can provide a relevant precedent in this regard. In such a scenario, it would be important that the host organisation could never become a creditor of the State involved in the insolvency proceedings, for obvious reasons of neutrality. This would be a ground to disqualify some organisations. Conversely, some international institutions that are not holders of State bonds (IMF, World Bank, BIS) could be potential host organisations for the proposed mechanism.
- Mode of operation: the Centre combines a conciliation mechanism between the debtor State and the representatives of holders of bonds issued by such State, with arbitral proceedings. More accurately, a conciliation is organised and, if it fails, arbitration proceedings can be initiated. Arbitration is thus envisaged as an incentive to reach an agreement in the framework of the preceding conciliation procedure.
- Jurisdiction of the Centre: as a matter of principle, the jurisdiction of the Centre is based on a jurisdictional clause inserted into the bond issuance contracts. Without such a clause, an a posteriori mechanism to accept the competence of the Centre is also proposed.
Other possibilities to establish the jurisdiction of the Centre might also be envisaged, for example, through consent expressed in a treaty.
The jurisdiction of the Centre does not cover all disputes that might stem from sovereign bond issuance contracts. It is limited to the adoption of a restructuring plan for the sovereign bonds concerned by the proceedings conducted under its aegis.
- Creditors’ representation: bondholders must be able to benefit from a collective representation vis-à-vis the State. A representation mechanism for a critical mass of bondholders is thus proposed. It features a representative tasked with the conduct of negotiations with the debtor State during the conciliation phase and, if need be, the arbitral proceedings.
- Scope of the proceedings: the initiation of the conciliation and, if need be, the arbitral proceedings entails the prohibition for all parties who gave their consent to the jurisdiction of the Centre to initiate any other proceedings before national jurisdictions (holding out strategies).
- Waiver of the immunities from jurisdiction and execution: the conciliation decision or the arbitral award is enforceable, and is accompanied by an automatic waiver by the debtor State of its immunities from jurisdiction and execution whose application would prevent the execution of the decision or the award on the territory of another contracting State.
- Supervision of the execution: it is proposed that the Secretariat and the Council supervise the execution of decisions and awards rendered in the framework of the Centre.
As regards the Secretariat: The issuer State has the obligation to regularly inform the Secretariat of the payments made pursuant to the decision or the award. If it experiences difficulties in their execution, it likewise has the obligation to inform the Secretariat. Faced with possible State’s difficulties in the execution, bondholders may inform the Secretariat. Such information is transmitted to the Council by the Secretariat and is reproduced in the annual report.
As regards the Council: In case of non-execution by the State of a decision or an award, the Council will take any measure it deems necessary and appropriate. Furthermore, it is also designed to develop institutional procedures to assist States in the execution of decisions and awards.