Sovereign debt defaults: Paradigms and challenges
Journal of Banking Regulation (2010) 11
Sovereign debt defaults: Paradigms and challenges
0 Rodrigo Olivares-Caminal
1 University of Warwick , Coventry , UK
2 UNCTAD , Geneva , Switzerland
It is an unfortunate fact that a sovereign nation
defaulting on its debt is now just a matter of
‘when’ not ‘if ’. Therefore, it is important
to briefly review the case of those sovereigns
that have recently defaulted or faced a serious
threat of a crisis. These include Argentina,
Ecuador, Iceland and Greece. These sovereign
debt crises are useful to comprehend the
complexities and possible implications of a
Argentina’s debt crisis started in late 2001
and is still baring this sovereign nation from
accessing the international capital markets.
Argentina’s default has certain particular
characteristics. It is the biggest default ever, in terms
of monetary amounts (more than USD 90
billion) and number of creditors (more than
700 000).1 Moreover, it has other complex
characteristics, that is the number of applicable
laws (eight)2 and the geographical distribution
of its creditors.
The role played by the Argentine
Government created a new precedent in the
international markets because it (1) adopted a defiant
position; (2) lacked dialogue with creditors;3
(3) proposed the biggest write-off in recent
bond restructuring’s history;4 and (4) exceeded
the precedents of the 1990s regarding the time
elapsed between the default and the date in
which the restructuring was finally
announced.5 Nonetheless, it is worth mentioning
that Belize, Grenada and Dominican Republic
– three subsequent restructurings – did not
follow the Argentine path and streamlined the
dialogue with creditors and the availability of
information avoiding disruptive situations.
Argentina has recently been planning to
reopen the exchange offer closed in 2005 to see
whether it is able to increase the number of
participants from 76.15 per cent to a more
respectable percentage in line with other
sovereign restructurings6 to re-gain access to
the international capital markets at competitive
The case of Ecuador is also interesting. A
recently elected President incorporated an
audit commission – known by its acronym
CAIC – with the mandate of analysing the
debt incurred by Ecuador to determine its
legitimacy, legality, efficiency and so on.7 The
audit report produced by the CAIC includes
several findings, mainly that there were several
cases in which Ecuador’s debt was incurred
by illegal and/or illegitimate means.
Some of the findings are as follows: (1) the
increase of the interest rates by the US Federal
Reserve in the late 1970s constitutes an illegal
practice;8 (2) the conversion of accrued
interests in arrears in Past Due Interest Brady
Bonds and Interest Equalization Brady Bonds
resulted in anatocism and therefore is illegal;9
(3) submission to foreign court jurisdiction is
contrary to Ecuadorian law;10 (4) waiver of
sovereign immunity is contrary to Ecuadorian
law;10 (5) maintenance of a relationship with
multilateral organizations (for example
International Monetary Fund (IMF)) is contrary to
Ecuadorian law;10 (6) the lack of registration of
certain bonds with the US Securities and
Exchange Commission are against the law;11
and (7) the choice of foreign governing law is
illegal under Ecuadorian law.12
As result of the findings, Ecuador defaulted
on its external debt and launched a cash
buyback offer. Although the buy-back offer can
be considered successful in relation to the
degree of participation, the price that Ecuador
will pay is very high. Ecuador’s reputation has
been seriously affected not only for defaulting
again (previously in 1995 and 2000), but also
because this default has been considered a
political rather than a financial default.13
In addition, Ecuador allegedly performed an
aggressively secondary repurchase via
intermediaries when the price for the defaulted 2012
and 2030 bonds hit rock bottom.14 To a certain
extent this reputational effect has been
acknowledge by Ecuador itself. In the Buyback
Circular, Ecuador – as if holding a glass ball to
foresee the future – stated: [g]iven the history of
defaults, and more recently, selective defaults, the
Republic may not be able to access the international
markets on favourable terms.15 Ecuador’s default
and buy-back transaction has been helpful to
keep on improving sovereign debt instruments.
New sovereign debt issuances will include
strict contractual provisions increasing the
standard of trustee responsibility in post-default
scenarios and prohibitions against a borrower
repurchasing its defaulted debt.16
Iceland and Greece are two ‘very alive’ and
ongoing cases. The case of Iceland involves
the recent collapse of Kaupthing, Glitnir and
Landsbanki, three internationally active
Icelandic banks. The collapse of these banks
has faced us with a different type of banking
crisis: a banking crisis that developed in a
currency crisis and escalated to a sovereign
debt default crisis with severe international
The Icelandic government did not have the
capacity to bail-out these institutions. This
inability of the government to save the troubled
banks led to a currency crisis that put Iceland
on the brink of a sovereign debt crisis. These
banks were both too big to fail and at the same
time too big to be saved.
In the recent global financial crisis, we have
seen various bailouts of troubled financial
entities. Although these bailouts have
contributed to restoring confidence in the financial
system in the short term, the question is at
what price. By reducing bank default risk,
sovereign default risk is increased in the long
term. Iceland is a small country with only
300 000 inhabitants, with a large internationally
exposed banking sector and with a limited
fiscal capacity. The central bank of Iceland
could have been an effective lender of last resort
if the banks were only exposed in domestic
currency, where printing money or taxing its
inhabitants would have been two possible
solutions but at a dear cost. However, the case
of Iceland is a case in which private financial
institutions were bigger than the country’s
The Icelandic case has severe connotations
as Iceland can be used to reassess the whole
theoretical notion of countries not being able
to become insolvent. Despite the fact that
sometimes it is said in a figurative manner that
a country is insolvent or bankrupt, technically
speaking, a country cannot reach this situation.
First and foremost, a sovereign state always has
the possibility of taxing its citizens, to dispose
of its resources (for example natural resources
or even part of its territory as it had happened
in the past with Alaska or Louisiana in the
United States), or even in extreme
circumstances it can recourse to the expropriation
of assets from its citizens.
In this assessment of recent sovereign debt
crisis, Greece is the latest addition. Greece is
facing a 13 per cent annual deficit and has a
75 per cent debt/GDP ratio reaching a very
delicate situation with the potential of spillovers
to other Euro-zone members. This case
provides some additional difficulties as it
touches upon sensible political issues. The
Greek situation has raised two main questions:
(1) if the European Union posses the powers
to rescue Greece despite the no-bailout clause
of the Treaty of Lisbon (articles 122 and 125);
and (2) if an IMF intervention is possible, in
other words what would happen if the IMF
provides assistance to Greece and in exchange
demands certain monetary policy or the
restructuring of its external debt? Would not
that conflict with the monetary policy of
the European Central Bank (ECB)? The first
question seems simpler because if there is
political will it can be argued that the
2008–2009 financial crisis constitutes an
‘exceptional occurrence beyond control’ despite
any alleged political manipulation and
bookcooking of the macroeconomic data. Although
the second question seems more difficult to
answer, it ends up being resumed to political
will again. The IMF and the ECB can design a
monetary policy that suits Greece’s needs and,
which, at the same time, complies with the
ECB policy toolkit.
As the Greek debt crisis rumbles on, with
Argentina expected to make a new offer to its
creditors imminently and Iceland still trying to
find a way out of their difficult situation, it is
also worth considering what a creditor can do
when a default occurs.
There are no international statutes to deal
with a sovereign debt default that leaves creditors
with a stark choice: to pursue litigation in court
or to enter into a restructuring deal (exchange
offer) with the sovereign debtor.
Litigation might seem an attractive
proposition at first as it offers debt holders the prospect
of obtaining favourable court rulings against a
sovereign debtor. However, in practice it is
very difficult to force the hand of a sovereign
debtor as, unlike proceedings against a
company, there are no practical sanctions that
can be placed on a sovereign nation within
its own territory. For example, it is not possible
to put a sovereign nation into liquidation or
replace the officials like the management in a
In addition, many sovereign assets held
outside a sovereign nation’s jurisdiction are
protected by sovereign immunity or under
international law such as embassies and
consulates and therefore cannot be cashed or taken
advantage of. Unprotected assets would be
quickly repatriated, which would make them
much harder to gain access to.
The risks and difficulties involved with
funding years of litigation, often across several
jurisdictions, means that legal action is only
appropriate for the most sophisticated distressed
debt funds who have both the time and money
to see the litigation through. For the majority
of creditors though, attempting to enforce a
ruling to gain assets through litigation may
prove to be a futile and hopeless labour.
Therefore, for most creditors, the best way
forward will be to enter into a market-based
solution with the debtor nation. So far the
market has managed to find solutions for almost
all sovereign debt defaults. Successful
restructuring episodes include Russia, Ukraine,
Pakistan, Ecuador (2000), Uruguay, Belize,
Grenada and so on.
Thankfully, future negotiations are
increasingly likely to succeed as ‘collective action
clauses’ (CACs) have become more prevalent
in bonds. A CAC allows a majority of
bondholders to agree to a debt restructuring
that then becomes binding on all bondholders.
This stops a minority of bondholders endlessly
preventing a restructuring from going
ahead – often in the hope of getting better
terms for their portion of the debt. However,
based on IMF data, more than half of tradeable
bonds do not include ‘collective action clauses’
(55.8 per cent in 2005), which could make
things harder for a creditor.
With or without a CAC in place, a potential
obstacle in any future sovereign debt
restructuring will be the introduction of new debt
holders such as China, India or Middle East
countries whose sovereign wealth funds are
now huge providers of liquidity and are
therefore likely to be stakeholders in any
negotiation they participate in. The same
applies to the case of bilateral lending.
However, as the status of these countries as
major creditors is new, they have not been
active participants in a sovereign debt
restructuring before. This, combined with the
frequently voiced concern that China’s policy
on lending is partly driven by geopolitics, could
see future sovereign debt restructuring taken
into completely unchartered territory should
they become involved as creditors in a default.
REFERENCES AND NOTES
Disclaimer The opinions provided are those of the author and do not necessarily reflect those of
the institutions that he represents.
1 Santiago Fittipaldi . ( 2003 ) Argentina: Bankers add uncertainty to Argentina debt restructuring . Global Finance December.
2 See Dr Nielsen , G. ( 2003 ) Speech of secretary of finance: Argentina's restructuring guidelines , http://www.argentine debtinfo. gov.ar/ing_presen.htm , 51 per cent of Argentine debt is subject to New York law, 18 per cent to English law, 17 per cent to German law, 11 per cent to Argentine law, 2 per cent to Japanese law and the remaining 1 per cent to Italian, Spanish and Swiss law .
3 See Financial Times . ( 2005 ) Editorial titled Argentina's foolish debt gamble . 14 January.
4 If a comparison is made between the 75 per cent obtained in terms of par value (66 per cent net present value) against Ecuador's 40 per cent or Russia's 36 per cent (Ukraine, Pakistan and Uruguay made no haircut), Argentina's haircut was much larger, and this could have discouraged participation by certain creditors, who opted to recover their claims through court actions .
5 On 13 January 2005 - after 36 months of default - Argentina released, by means of Resolution 20/05 issued by the Ministry of Economy, the final offering prospectus and supplement including the terms and conditions of the exchange offer .
6 For example, in the exchange offers performed in the late 1990s or early 2000s, Russia managed to obtain 98 per cent participation, Ukraine 95 per cent, Ecuador 97 per cent, Pakistan 99 per cent and Uruguay 93 per cent .
7 See Ecuador's Presidential Decree No . 472, article 2 .
8 See Comisi o´n para la Auditor´ıa Integral del Cre´dito P u´blico, Final Report of the Integral Auditing of the Ecuadorian Debt Audit , pp. 26 and 150, http://www 9 10 11 12 13 14 15 16 .auditoriadeuda. org.ec/index.php?option=com_content& view=article&id=89.
See Comisi o´n para la Auditor´ıa Integral del Cre´dito P u´blico, Final Report of the Integral Auditing of the Ecuadorian Debt Audit , pp. 42 and 151, http://www .auditoriadeuda. org.ec/index.php?option=com_content& view=article&id=89.
See Comisi o´n para la Auditor´ıa Integral del Cre´dito P u´blico , Final Report of the Integral Auditing of the Ecuadorian Debt Audit , p. 42 , http://www.auditoriadeuda . org.ec/index.php?option=com_content&view=article&id=89.
See Comisi o´n para la Auditor´ıa Integral del Cre´dito P u´blico, Final Report of the Integral Auditing of the Ecuadorian Debt Audit , pp. 42 and 150 - 151 , http://www .auditoriadeuda. org.ec/index.php?option=com_content& view=article&id=89.
See Comisi o´n para la Auditor´ıa Integral del Cre´dito P u´blico, Final Report of the Integral Auditing of the Ecuadorian Debt Audit , pp. 28 and 51, http://www .auditoriadeuda. org.ec/index.php?option=com_content& view=article&id=89.
See Felix Salmon , Market Movers , Portfolio.com, dated 12 December 2008 , http://www.portfolio.com/views/blogs/ market-movers/ 2008 /12/12/ecuadors-idiotic-default/.
Miller , B. ( 2009 ) Ecuador restructuring: Inside job . Latin Finance 1 July.
Ecuador Noteholder Circular dated 20 April 2009 to submit in a modified Dutch auction to sell Bonds for Cash , p. 18 .
See Buchheit , L. and Gulati , M. ( 2009 ) The coroner's inquest . International Financial Law Review September: 4.