The Roles of Financial and Legal Advisors

The Approach from Financial and Legal Advisors During a Sovereign Debt Crisis

» Global Macro-Environment Backdrop

» Surge in Sovereign Debt Crises

» Why does Specialised Advice Matters?

» How Advisors Can Help?

» Debtors’ Perspective

» Creditors’ Perspective

» Sovereign Debt Restructuring Lessons

» Retaining Financial and Legal Advisors

» Conclusions and Q&As

Global Macro-Environment Backdrop

The global economy has is facing unprecedented structural shocks emanating from the Covid 19 pandemic, massive geopolitical shifts, and the normalisation of monetary policy in developed nations. The need to address rampant inflation has led to a rapid rise in global interest rates and the value of the US dollar. These developments are having significant implications on the evolution of debt sustainability across sovereigns:

» Sovereign debt is at unprecedented high levels and the global stock of public debt is set to increase further placing huge risk management pressures on sovereign debt portfolios

• The IIF estimates that EM debt alone totalled US$98 trillion in 2022, 31% increase vs 2021

» Payment capacity has deteriorated at a rapid place in a number of DC and LICs; the prospects for financial stress and a potential SDRs is increasing

• 7 sovereigns are restructuring their debts, and a number of others are set to follow suit

» Restructuring these liabilities is proving a challenge not least because creditor bases have evolved dramatically over the past decade

• The share of debt owed to China and commercial creditors have grown in importance

Surge in Sovereign Debt Restructurings

On account of such unprecedented global conditions, IFIs and MDBs, together with the G-20 (Paris Club and non-Paris Club countries), sought to develop options for sovereign countries facing debt sustainability issues

» Debt Service Suspension Initiative (DSSI) was introduced for the poorest countries in April 2020

• 73 countries were eligible but only 40 participated rescheduling US$10.3 billion in payments

» More was needed to assist governments address financing shortfalls and rapid accumulation in public sector debt positions – the Common Framework (CF) for debt treatment was in introduced in November 2020

» Only four countries have requested treatment under the CF – but one (Chad) has managed to secure necessary debt relief

» Delays in securing debt relief have been a consequences of:

• Protracted formation of official (bilateral) creditors committee (OCC) and oordinating action among all creditors -- official and private sector

• Understanding creditor requirements and constraints

• Lack of sovereign debtor capacity assessing debt sustainability

Why does Specialised Advice Matters?

Sovereign Debt Restructurings are complex situations that require decisive and immediate policy actions

» Each sovereign crisis is different and unique

• Assessing the causes is critical

• Creditor bases are growing ever more diverse and heterogeneous

» The design of an appropriate reform programme to address economic imbalances and restore fiscal and debt sustainability is paramount

» This will require financial and technical assistance from all stakeholders

• Multilateral assistance is the first port of call

• Stakeholder support, including creditors, is also important

» Transparency, fairness and adequate disclosures are necessary

» Capacity building takes time

How Advisors Can Help?

If restructuring of sovereign debt is required, a credible process is necessary to minimise disruption and impact as well as to accelerate the resolution. Financial and legal advisors bring expertise and experience

» Assessing the nature of the imbalance

• Liquidity versus solvency

• Validation of debt sustainability and payment capacity

» Formulation of fair and credible engagement and negotiation with creditors is critical

• Creditors should be treated as stakeholders

• Transparency, fairness and equitable process

» Engagement with creditors may be complex

• Understanding financial interests and constraints is important

• Creditor coordination is necessary

• Documentation of agreed resolution is time consuming

Debtors’ Perspective

Governments employ every tactic to avoid a restructuring of public sector debt until it is late. Governments often ignore potential debt sustainability issues, whether related to chronic illiquidity conditions or longterm solvency, until financial resources are all but exhausted, including approaching the IMF for financial assistance

» The CF was modelled on traditional Paris Club processes and traditions employed when developed western countries' claims on low-and middle-income debtor governments represented a significant percentage of total public sector debts. This made a sovereign debt restructuring under an IMF programme easier to implement, as the Paris Club was able to set the tone for the process

» Creditor bases have evolved significantly, with diverse commercial and traditional non-Paris Club creditors now representing a majority segment of total public sector debts in many LICs and MICs

• The CF has not aptly facilitated a reorganization of liabilities. The process is proving protractive, time consuming and is leading to greater financial and social disarray for a debtor country

• The CF does not currently provide guarantee that all creditors will act in concert to help address the causes of a sovereign debt crisis

» IMF must remain an independent arbiter to assist in the formulation and implementation of a credible reform programme to address economic imbalances and restore long-term growth

Creditors’ Perspective

Private sector creditors need to answer to their own investor constituencies. They expect to understand the financial rationale for debt relief. The CF does not adequately address asymmetry of information

» Debtor governments need to engage in good faith efforts to disclose timely and accurate information to all creditors, with information asymmetries between official and private creditors being minimised

• A complex situation given regulatory and legal requirements imposed on market participants. However, the definition of data to be shared should be clear and time bound

» The responsibility is on the debtor government to post the required data on an information-sharing platform

» Seeking to maximise debt relief by squeezing creditor constituencies is contra-productive and leads to standoffs that harm the potential future economic prospects of a debtor country, and ultimately the most vulnerable

» Seeking to create financial buffers through excess debt relief not only creates a sense of distrust among creditors, but may increase legal risk for the debtor government, often at great expense at a time when financial resources are scarce and should not be wasted

Some Important Lessons

» Addressing Economic Imbalances

Understanding economic challenges and developing a broad based reform plan to address economic imbalances, strengthen social safety nets as well as promote inclusive and sustainable growth, is vital -- the importance of credible reforms cannot be stressed enough

» Debt Restructuring Must Complement Credible Reforms

A sovereign debt restructuring in isolation is not a panacea for resolving economic imbalances. A debt restructuring must complement a credible reform programme

» Multilateral Support

Multilateral institutions are critical stakeholders that should support a strong reform agenda, via financing, technical assistance and capacity building efforts

Some Important Lessons

» Formulation of a MTDS

Developing a comprehensive Medium Term Debt Management Strategy (MTDS) is vital to assess debt sustainability requirements and assess inherent risks in the sovereign debt portfolio

» Viable Communication Strategy is Vital to Engage all Stakeholders

If a debt restructuring is necessary, engage early in a transparent and orderly manner with all stake holders

» Engage financial and legal advice early

Engagement of competent financial and legal advisors should be sought early and in transparent manner to assist with the formulation of adequate solutions and strategies to engage with creditors. Creditors are stakeholders and interests can be aligned to ensure a country in crisis emerges stronger

» Process Matters

Consensual negotiations based on an open exchange of views and ensuring inter-stakeholder equity (burden sharing) is necessary to build consensus and foster support for critical reforms

Retaining Financial and Legal Advisors

The Appointment of financial and legal advisors need not be difficult or controversial

» Select experience and expertise

• Seek references

» Demand engagement with all stakeholders to outline financial needs and constraints

» Employ a transparent and fair process

• Request for proposals

• Avoid complexity

» Assess potential resolution options

» Demand accountability

» Understand costs

Conclusions

1. Governments in a crisis situation need to understand the causes and nature of economic imbalances

2. Comprehensive, substantial and credible economic reforms formulated. Restructuring public sector is not the panacea

3. Multilateral support is vital

4. Broad Stakeholder support is necessary. Efforts to squeeze private sector creditors delays the process

5. Proactive, orderly, equitable/fair, and consensual restructuring process

6. Heed market signs and indications / prices and yields

7. Process matters – a strong communications / engagement strategy

Contact Information

Rafael M. Molina

Newstate Partners LLP

2 Duke Street

London SW1Y 6BN

United Kingdom

Phone: +44 20 3077 4914

E-mail: rmolina@newstatepartners.com

Website: www.newstatepartners.com

Authorised and Regulated by the Financial Conduct Authority

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Newstate Partners LLP ("Newstate") exercises reasonable care and takes appropriate precautions to ensure that the information contained in this presentation is accurate, up-to-date and reflects our understanding of your requirements. Any proposal or recommendation contained in this presentation is given in good faith and based on information currently available to Newstate. Newstate reserves the right to change its recommendation based on further information received by it (whether from you or from third parties). Nothing in this presentation is an offer by Newstate to enter into contractual relations with you