AN INSOLVENCY FRAMEWORK FOR PIIGS OR HOW TO DISMANTLE AN ATOMIC BOMB.

1.      Why do PIIGS need a SDRM

      During the last decades, globalisation and proliferation of international commerce and investment have caused a radical change in international financial markets. World economic expansion, together with economic integration has created new ways of financing which have changed the physiognomy of international financial crises. The current PIIGS crisis brings back the focus on how the world should address the situation of countries that are forced to restructure its debt and the need for a framework to resolve debt crises. Greece has provided a warning on the fragility of the international financial system at the beginning of 2010 and it will not take long until another country sends new signals of a desperate need for debt restructuring. In this context, financial institutions have adopted spasmodic actions to address the situation over the past decades. However, financial markets should start worrying about finding long term solutions to avoid last minute decisions once a new debt crisis explodes.

      With the exception of those situations where there was a voluntary negotiation between creditors and sovereign debtor, the rule was that when a country declared a moratorium, creditors started independent actions against the sovereign debtor. However, the uncertainty of the results of litigation and the fact that legal actions against defaulting states take several years, are some of the main factors that triggered some proposals to find an alternative dispute resolution procedure for these situations. Although financial markets have evolved throughout the years, there has not been any change in the procedures to solve international financial crises. The current dispute resolution procedure for sovereign debt crises is obsolete and a new system must be found.

      In this context, a Sovereign Debt Restructuring Mechanisms (SDRM) would address the problem of  unsustainable sovereign debt by providing a legal framework where the sovereign debtor and its creditors can negotiate in good faith a solution for a sovereign debt problem. The PIIGS crisis which now puts in danger the developed economies with a potential risk of affecting the entire global economy require strong and precise actions and, in particular, a statutory mechanism to make the decisions of a majority of creditors in the restructuring process, binding on all creditors.

2.      Getting to Work. Principles and rules of a SDRM.

      A SDRM should follow at least three main principles. First, a SDRM should provide equal protection to debtor and creditors in order to negotiate in good faith a solution for the sovereign debt. The SDRM should seek to protect the sovereign debtor from abuses but at the same time, it should impose strong sanctions to the sovereign debtor, when it breaches the agreement with creditors. Secondly, the SDRM should only be applicable to those countries which voluntarily agree to submit that process. Thirdly, a SDRM should be based on the principle that the decision of the majority should be binding to all creditors. One of the main problems that sovereign debt crises pose is the diversity and number of creditors. The rationale behind any insolvency procedure is that the debtor will have the possibility to negotiate on an arms-length basis with its creditors and at the end of the negotiation it will have to make a proposal which should be accepted by its creditors.

      With these principles in mind, the question now turns to the main issues to be legislated in a SDRM, namely:

1.      A SDRM should clearly define the persons and circumstances under which it may be filed.

2.      A SDRM should foresee an automatic stay after a SDRM has been filed.

3.      A SDRM should establish a procedure for verification of claims by creditors.

4.      A SDRM should allow for a negotiation period between creditors and the sovereign debtor. The result of these negotiations should be reflected in a Sovereign Debt Restructuring Plan.

5.      The decision of the majority regarding the Sovereign Debt Restructuring Plan should be binding on all creditors and on the sovereign debtor.

6.      A SDRM should include a procedure for enforcing the Sovereign Debt Restructuring Plan in case of breach by the sovereign debtor.

7.      A neutral international court is essential to guarantee the transparency of the process, but also to protect the sovereign debtor and its creditors during the negotiations.

3.      The Road Beyond

      Sovereign debt crises represent an increasing problem in the world economy and an obstacle to development. A SDRM would address the problem of sovereign debt crises by providing an institutional framework for a sovereign debtor and its creditors to find a solution for a debt crisis. However, there are still some issues that need to be solved. First, a SDRM cannot facilitate default on sovereign debt. Secondly, a SDRM can project an unnecessary rigidity in the market. That rigidity would be evidenced by a restriction in the lending to sovereign borrowers and in higher interest rates that those sovereign borrowers will have to pay to its lenders. Finally, these kinds of reforms depend on a political decision and it will not be possible to have this procedure in place until such political decision is made. However, given the time, efforts and money that G-20 countries are putting in debating the nature and solutions to the crisis, it is crucial to take concrete steps towards a solution before the next crisis explodes.