Sovereign debt defaults: Paradigms and challenges

Guest Editorial Sovereign debt defaults: Paradigms and challenges Journal of Banking Regulation (2010) 11, 91–94. doi:10.1057/jbr.2010.8 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 sovereign default. 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 interest rates. 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 & 2010 Macmillan Publishers Ltd. 1745-6452 Journal of Banking Regulation www.palgrave-journals.com/jbr/ Vol. 11, 2, 91–94 Guest Editorial 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 connotations. 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 92 r 2010 Macmillan Publishers Ltd. 1745-6452 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 own economy. 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 c (...truncated)