Vol 7 (2010) - Issue 2

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Sovereign Debt Restructuring: Examining the Application of Collective Action Clauses

State contractual liability: the backdrop

'Consequent to the global phenomenon of economic recession and as the sub-prime crisis becomes more and more prominent; the realities of bankruptcy are staring corporations in the face. It will not be long before the brunt is transmitted to the State as a borrower'.

With the increase in global liquidity and market integration, the international financial markets have witnessed new investment opportunities. While investors have continuously struggled for maximum returns and diversified risks – which created demand and liquidity for novel financial products, the developing countries, or emerging markets, matched this demand by exploiting different ways to access this much-needed international capital. It is necessary to understand the background of such events in the past, primarily the world debt crisis of the 1980s, where sovereign debts were chiefly held by commercial bank syndicates. The stage that soon followed was where sovereign borrowers began to meet their debt requirements from international financial markets, which offered an easy and accessible option for countries with scarce capital sources. But the capital markets were volatile and borrowing countries were exposed to unstable financial risks, and they often defaulted on their debt obligations. This necessitated countries to manage their debt either by way of immature debt satisfaction or debt rescheduling. Paying up was not always considered a viable option and rescheduling or restructuring of the debt was being opted in a more aggressive way. The effects of issuing public debt, both domestic and external have been the subject of substantial scrutiny and analysis.

State as a borrower: the restructuring mechanism

A series of recent sovereign defaults and restructurings have thrown open interesting challenges to various factions of this transaction comprising of debtors, investors, academician and lawyers. The enormous consequences of mismanaging international public debt have generated significant scrutiny and analysis. A general consensus seems to have emerged that sovereign debt restructuring mechanisms need to be more orderly and economical. While workable mechanisms of rescheduling sovereign debt obligations have since emerged, the procedures employed entail the creditors sharing the burden of reduction of their claims against their investments.