Crisis Talk — with Lee Buchheit on EM's coming sovereign debt crisis
Lee Buchheit is a veteran of sovereign debt restructuring and is considered by many to be a world expert in the field. He has worked on debt restructuring among many of the emerging markets countries, including Argentina, Greece and Venezuela. GlobalCapital caught up with him this week to discuss the debt crisis gripping the EM universe, and how private sector creditors should approach requests for debt standstills.
GlobalCapital: Have private investors woken up to the reality of debt relief?
Lee Buchheit: The private sector appears to have accepted the G20’s call for the debt service standstill for IDA [International Development Association] countries. I think they did that because private sector exposure to IDA countries is a fraction of what the bilateral/official sector holds — about 25%. It was not, therefore, the private sector ox that got gored by the G20’s statement.
Expanding the standstill idea to middle income countries [MICs] causes considerable handwringing because that is where the private sector money is.
How constructive has dialogue on debt relief been so far?
It has been constructive to a degree. The March 25 statement of the president of the World Bank and the managing director of the IMF calling for bilateral creditors to standstill on debt service payments until the end of the year was a significant step.
The fact that the G20, which includes China, the world’s largest bilateral lender, said that it would accept a standstill for the IDA countries was helpful. While the G20 genuflected in the direction of private sector creditors also providing comparable debt relief, they did not insist on it.
For the IDA countries the private sector is a minority creditor element. The huge issue that is going to have to be confronted real soon is the predicament of the middle-income countries.
A number of these countries are going to be faced with a truly odious choice: either they won’t have the dough or, if they do have the dough, they will come under domestic political pressure to apply it to crisis measures and not debt service.
Their choices, as I see it, are three: they can just cease debt service altogether and slip into hard default. Or they could negotiate a standstill with each creditor, perhaps even instrument by instrument. Or there could be some uniform, consistent, official sector-blessed mechanism for arranging the standstill.
The first of those, straight-out defaults, is the worst as it propels us into a global debt crisis.
But the second is impractical. It would take months for a county to negotiate, on a bespoke basis with each of its creditors, a request for a standstill for each of its instruments. And even if they attempted it, the result would be a dog’s breakfast of financial and legal terms for standstills that would be incongruent with each other and would not satisfy the objective of inter-creditor equity.
That leaves the third option. The proposal that I joined last week was one species under the broader genus of uniform, consistent mechanisms for implementing the standstill.
A number of MICs will have no option but to choose one of those three approaches. To my mind, the third is the only acceptable one.
How would the mechanics of that work?
The idea would be that the debtor country would set up a central credit facility (CCF) with a multilateral development bank (MDB). The debtor country would then pay the interest falling due during the standstill period, on both its commercial and bilateral debts, to the MDB for deposit in the central credit facility. The creditors that were entitled to those interest payments would receive, in lieu of the interest payments, interest in the CCF.
The CCF would then be available to be drawn down to finance Covid-19 related expenses and only those expenses. So you would then have a pool of funds representing redirected or reinvested interest payments on existing debt instruments that could then be used to fund crisis amelioration.
It has three virtues. First, you could do it quickly. It would only require the setting up of a CCF, and after that it will be in the hands of the country to begin diverting interest payments into that facility.
Second, individual commercial creditors will not be in a position to monitor the use of the money, but the MDB will. There is a risk in some countries that this money could be used for purposes that are not linked to Covid-19. My fear is that we all wake up one morning to a headline saying that the money that had been the subject of interest forbearance wound up being used to buy a Lear jet for a country’s president. If the payments went through an MDB, it could monitor the use of proceeds and make sure the money was going where it was supposed to go.
The third benefit is it treats everyone identically, because everyone, bilateral or commercial creditor, whose interest payment was diverted to this facility, will receive the same consideration: a corresponding interest in the facility.
What has feedback from private investors been like on this idea?
The feedback seems to be positive. Obviously, they would love this cup to pass from their lips but if they cannot have that, they have two principal concerns. The first is that the money is actually used for the humanitarian concerns that they are telling their end investors is the reason why they are giving this forbearance.
Second, they are concerned about equal treatment — both with other commercial creditors and the bilateral lenders. The CCF idea achieves both of those objectives.
Obviously, not all of them are going to like it, but we are talking about an unprecedented emergency and most private creditors realise that some degree of forbearance is going to be required here.
You have had to negotiate with many vulture funds during your career. Are they a risk here?
The risk of a creditor pursuing a legal remedy for a redirected interest payment should be relatively small for three reasons.
One is the reputational issue.
The second is that if the standstill lasts for 12 months it equals at most two interest payments. And even if a creditor sued and got a judgement for that amount, their recoverable damages would be the amount of the two missed coupons minus the market value of the interest in the CCF that they received in lieu of those interest payments. So that narrows the amount of money to the point that it should not act as a beckoning finger to the plaintiffs’ bar.
But there is another element. We all know that when this crisis abates there will be some countries that will have unsustainable debt positions. We went into the crisis with a world awash in debt at almost every level. Some of these countries were potentially in distress even before this started, and if the effects of the crisis linger, and many economists think that they will, these countries will have unsustainable debts. It is in the interests of commercial creditors generally that if a debt restructuring is needed, for it to be an orderly process.
The vast majority of commercial creditors will not want to see maverick members of their club accelerating debt instruments and pursuing lawsuits. These are actions that would catapult this situation into an irreversible debt crisis for the country concerned.
Also, under the terms of most bonds today, 25% of bondholders’ consent is required to accelerate payment obligations and typically 50% of bondholders can reverse an acceleration. So the majority of creditors have a degree of control over bonds that they wouldn’t have had 20 years ago. That is useful and I would hope that the broad sweep of bondholders would see it in their collective interest to suppress maverick behaviour in a situation like this.
Is talk of debt relief hampering market access for lower rated EM credits?
I don’t think so. History says that the political class in these countries avoids asking for debt relief until the last moment. And they often delay well beyond the point that they should have acted. A finance minister who thinks that the country may continue to have market access will not want to signal debt distress by joining a standstill even if it means using monetary reserves to continue normal debt service. There will be a number of countries that will decline to participate altogether, either because they are not so badly affected by the crisis, or because they think that they are better off in the long run keeping the normal debt service going until this tsunami passes over. If I were an investor I would not worry about countries casually or unnecessarily jumping onto a debt standstill bandwagon. The countries who do it will be the countries who need to do it.
Finally, how does this situation compare to previous sovereign debt crises that you have worked on?
This is the first time since the 1980s that we have seen or are about to see a truly contagious sovereign debt crisis. Back then, 27 countries got pushed to the wall by the same phenomenon, which was a spike in Libor interest rates that that topped out in 1981 at 22%.
While we have seen sovereign debt crises break out since then, they have been relatively localised and there hasn’t been a situation in the intervening 35 years that has affected multiple countries simultaneously. This pandemic is pretty much the definition of such a situation. And while I hope that I am wrong, we could by the end of year see a number of countries having to restructure their external debts. That will place an enormous amount of pressure on a number of financial institutions.