OREANDA-NEWS. On December 8, 2015, the Executive Board of the International Monetary Fund (IMF) discussed the staff paper “Reforming the Fund's Policy on Non-Toleration of Arrears to Official Creditors” and the supplementary information issued prior to the Board meeting, which amended and clarified the staff’s initial proposal.

The staff paper follows up on the Executive Board’s guidance to Fund staff in May 2013, which stemmed from an earlier staff paper: “Sovereign Debt Restructurings—Recent Developments and Implications for the Fund’s Legal and Policy Framework.” That paper reviewed the recent application of Fund policies and practices on sovereign debt restructuring and identified a number of issues for further in-depth study. The Executive Board agreed in May 2013 that these issues required follow-up work and asked staff to present options for reforming the Fund’s policy framework in each of the following areas: (i) the relationship between the Fund’s lending framework and sovereign debt vulnerabilities; (ii) the effectiveness of the contractual, market-based approach to debt restructuring in overcoming collective action problems; (iii) the framework for official sector involvement; and (iv) issues related to private sector involvement in debt restructurings including the lending-into-arrears policy.

The latest staff paper focuses on the Fund’s policy on official sector involvement, proposing a reform of the Fund’s policy on non-toleration of arrears owed to official bilateral creditors which Fund staff has advocated for since 1989. This proposal aims to strengthen incentives for collective action among official bilateral creditors when official sector involvement in a debt restructuring is necessary. The proposal envisages a two-step process, whereby the Fund would first encourage the debtor and its creditors to reach a representative collective agreement or, failing that, agreements with each creditor. If, after this process has run its course, there remain creditors who are unwilling to reach an agreement with the debtor and do not consent to Fund financing despite arrears owed, the Fund would nevertheless consider lending into arrears owed to official bilateral creditors where specific criteria were satisfied. Importantly, the policy will provide appropriate safeguards for official bilateral creditors, as any decision to lend into arrears will be subject to the debtor’s good faith efforts to reach agreement with its creditors, will be applied in a way that preserves the Fund’s ability to mobilize official financing packages in the future, and will be subject to the Executive Board’s approval, case by case.

Executive Board Assessment

Executive Directors welcomed today’s discussion of proposed reforms to the Fund’s policy on non-toleration of arrears to official bilateral creditors, one of the issues under the sovereign debt restructuring work program that was endorsed by the Executive Board in May 2013. They reiterated that the other three work streams—reforming the Fund’s lending framework, strengthening the contractual approach to address collective action problems, and reviewing the Fund’s lending-into-arrears policy—also remain critical to facilitate timely and orderly sovereign debt restructurings where these are necessary, thereby minimizing the associated costs for debtors, creditors, and the international financial system.

Directors noted that the changing landscape for official finance warrants a review of the Fund’s policy on non-toleration of arrears to ensure that, where a restructuring is deemed necessary, collective action among official bilateral creditors is encouraged and the provision of Fund support is not held up by the unwillingness of hold-out creditors to join an effort that is supported by an adequately representative group of creditors. Directors recognized that prompt provision of support maximizes the value of creditors’ claims (or minimizes their losses) and maintains the debtor’s capacity to service its debt. They underscored that the reform proposal does not alter the current practices whereby the terms of debt treatment offered to official bilateral creditors have typically been more favorable than those received by private creditors. They also stressed that the proposal does not imply any increase in the frequency with which official bilateral creditors may be called upon to restructure their claims in future cases.

Directors highlighted that the financing that official bilateral creditors provide during crises is often critical for the success of Fund-supported programs. They emphasized, therefore, the importance of minimizing instances of arrears to official bilateral creditors. They concurred that any decision to provide financing despite the arrears should be based on a determination that it would not have an undue negative effect on the Fund’s ability to mobilize official financing packages in future cases. Directors underlined the need to strike an appropriate balance between the Fund’s ability to provide timely support while maintaining important safeguards for official bilateral creditors.

In light of the above considerations, nearly all Directors endorsed the following revision to the policy on non-toleration of arrears to official bilateral creditors:

If an agreement is reached through the Paris Club that is adequately representative, the Fund would rely on its current practices—i.e., arrears would be considered eliminated (for purposes of the application of this policy) for both participating and non-participating creditors when financing assurances are received from the Paris Club in anticipation of an Agreed Minute. Should another representative standing forum emerge, the Fund would be open to engaging with such a forum.

In circumstances where an adequately representative agreement has not been reached through the Paris Club, the Fund would consider lending into arrears owed to an official bilateral creditor only in circumscribed circumstances where all the following criteria are satisfied:

• Prompt financial support from the Fund is considered essential, and the member is pursuing appropriate policies;

• The debtor is making good faith efforts to reach agreement with the creditor on a contribution consistent with the parameters of the Fund-supported program—i.e., that the absence of an agreement is due to the unwillingness of the creditor to provide such a contribution; and

• The decision to provide financing despite the arrears would not have an undue negative effect on the Fund’s ability to mobilize official financing packages in future cases.

In applying the above criteria, the Fund will need to exercise judgment based on case-specific circumstances. In exercising this judgment, the Board will be guided by the following considerations:

First, an agreement will be considered “adequately representative” when it provides a majority of the total financing contributions required from official bilateral creditors over the program period. “Contribution” here comprises, and is limited to, debt relief and new financing (e.g. loans, bond financing, guarantees, and grants).

Second, in assessing whether a debtor is acting in good faith, the Fund will consider, inter alia, whether the debtor has approached the creditor to which it owes arrears either bilaterally or through a relevant grouping of official bilateral creditors, recognizing that the latter may take several forms, including ad hoc creditor committees; has offered to engage in substantive dialogue with the creditor and has sought a collaborative process with the creditor to reach agreement; has provided the creditor relevant information on a timely basis consistent with the Fund’s policy on confidentiality of information; and has offered the creditor terms that are consistent with the parameters of the Fund-supported program. If the debtor requested terms from an official bilateral creditor that would result in financing contributions that exceeded the requirements of the program it would generally not indicate good faith. Finally, an assessment of the second criterion would also take into consideration the extent to which a creditor is being asked to make a contribution that is disproportionate relative to other official bilateral creditors.

Third, in assessing whether the Fund’s decision to lend into arrears owed to an official bilateral creditor would have an undue negative effect on the Fund’s ability to mobilize official financing packages in future cases, the Fund will consider the signal that such a decision would send to official bilateral creditors as a group, given the specific circumstances of the case. In particular, this criterion would normally not be satisfied where the creditor or group of creditors that has not reached agreement with the debtor accounts for an adequately representative share, i.e., a majority, of total financing contributions required from official bilateral creditors over the program period, as defined above. Separately, an assessment of whether the third criterion is satisfied would take into consideration the creditor’s track record of providing contributions in past debt restructurings under Fund-supported programs, even if the creditor does not account for an adequately representative share of total financing contributions.

An official bilateral creditor may choose to consent to Fund financing notwithstanding arrears owed to it. In such cases, the Board would not need to make a judgment as to whether the three criteria above are satisfied. The Fund would nevertheless continue to encourage the parties to come to an agreement during the program, since the regularization of arrears is an objective of any Fund-supported program and important for the functioning of the international financial system at large.

There may be emergency situations, such as in the aftermath of a natural disaster, where the extraordinary demands on the affected government are such that there is insufficient time for the debtor to undertake good faith efforts to reach agreement with its creditors. When a judgment has been made that such exceptional circumstances exist, the Fund may provide financing under the Rapid Credit Facility (RCF) or the Rapid Financing Instrument (RFI) despite arrears owed to official bilateral creditors and without assessing whether the three criteria above have been satisfied or obtaining the creditor’s consent. However, it would be expected that the Fund’s support provided to the debtor in such cases would help advance normalization of relations with official bilateral creditors and the resolution of arrears, so that the approval of any subsequent Fund arrangement for the member would again be subject to all three criteria set out above.

This policy will enter into effect immediately and will apply to all future purchases or disbursements (including under existing arrangements), with respect to existing and future arrears. Further, so long as unresolved arrears owed to official bilateral creditors are outstanding, every purchase or disbursement made available after the approval of the arrangement will be subject to a financing assurances review by the Board and verification that all three criteria are satisfied to determine whether this policy continues to be met for the further use of the Fund’s resources in the member’s circumstances.

In supporting the reform proposal, many Directors expressed the view that it would be important to preserve comparability of treatment across official creditors. Some Directors also stressed that Fund financing in emergency cases under the RCF or the RFI without an assessment of whether the three criteria have been satisfied is expected to be rare and limited to a small sub-set of cases.

Notwithstanding their general support of the proposal, a few Directors expressed some reservations about the term “normally” used in the third criterion above, noting the risk that it may be applied in a manner that is not consistent with the principle of uniformity of treatment. In this regard, Directors agreed that any evaluation of this criterion in these abnormal circumstances should be in line with the Fund’s mandate and based exclusively on a determination as to whether the Fund’s decision to provide financing despite the arrears would have an undue negative effect on the Fund’s ability to mobilize official financing packages in future cases.

A few Directors raised concerns that the reform may not provide adequate protection to official bilateral creditors vis-?-vis private creditors. Directors were generally satisfied, however, that the policy preserves important differential safeguards for official bilateral creditors, including the requirement that the third criterion be satisfied.

Directors agreed that, given the importance of this policy change, and depending on the complexity and number of cases that arise, the policy may need to be reviewed within a relatively short period, namely, two to three years.