MACROECONOMICS, TRADE AND INVESTMENT E Q U I TA B L E G R O W T H , F I N A N C E & I N S T I T U T I O N S N OT E S Achieving Comparability of Treatment under the G20’s Common Framework Diego Rivetti The objective of the Common Framework (CF) is to design and implement a debt restructuring package that can fill a debtor’s financing gap in the short-term and restore its debt sustainability in the medium-long term. To achieve this dual goal, a CF treatment should be accepted by both official bilateral and commercial creditors, who have different portfolios, incentives, and restructuring practices. The current CF architecture relies on the application of the Paris Club’s (PC’s) principle of comparability of treatment (CoT). However, CoT - in its current form – is not being enforced, does not distribute the burden of debt reduction equally among creditors, and does not guarantee compliance by private creditors, except for “light” restructurings. This note proposes two main reforms to address this challenge: (i) carrying out coordinated and simultaneous negotiations across creditors and (ii) using NPV reduction based upon a common discount rate as the only measure of CoT. CoT: PC’s definition and enforceability CoT is the PC’s principle aimed at assuring PC members that creditors relative to private creditors.6 In fact, Schlegl et al. their claims are not subordinate to those of private institutions show that, in past restructurings, the average difference in or other bilateral lenders that do not belong to the group.1,2 NPV reduction between the official and the private creditors The CoT is assessed ex-post by the PC on the basis of one or is greater than 20 percentage points.7 Yet, the Paris Club has more of the following parameters: never withdrawn a debt treatment on comparability grounds.8 a. Change in nominal debt service over the consolidation Moreover, the timing of the agreements with private creditors period.3 The PC refers to “a strict proportional breakdown does not suggest alignment with the CoT’s request. Private of the efforts among creditors” i.e., each creditor should restructurings may occur years after the PC’s treatment. In contribute to bridging the financing gap proportionately some cases, a deal with bondholders was achieved before the with the maturities (in principal and interest) falling due PC’s decision (e.g., Ukraine, Russia, or Ecuador).9 over the consolidation period;4 (See example in Figure 1) b. Debt reduction in NPV terms. In its methodological note, The heterogeneity in CoT outcomes and the timing of the the PC maintains that a single discount rate should be official vs. private relief signal that CoT’s “moral suasion” used for all creditors to ensure comparability. has not been the key driver in the negotiations of the c. Extension of the duration of the treated claims. The borrower with its private creditors. Private creditors’ goal duration is measured in absolute terms (years) rather is to maximize their financial recovery. Therefore, the key than relative to the duration of the original claims. drivers in their restructuring strategies are the following: (i) the default status, with resulting missed cash-flows and mark-to- The discretional use of one or more of the above indicators market losses in their balance sheets, (ii) the assumptions on gives the PC significant leeway in determining whether CoT the length of the restructuring process, (iii) the expectation on is achieved. As a result, CoT has been generously evaluated, the future pricing of the restructured instruments and (iv) the often considering country-specific mitigating factors,5 even ability to enforce the borrower’s payment obligation.10 when greater levels of debt relief were granted by official 1. Although de facto in place throughout the history of the PC, the CoT principle was officially introduced with the Evian approach in 2004. 2. The wording currently in use is the following: “In order to secure comparable treatment of its debt due to all its external public or private creditors, the Government of X commits to seek promptly from all its bilateral and commercial external creditors debt reorganization arrangements on terms comparable to those set forth in these Agreed Minutes, while trying to avoid discrimination among different categories of creditors. Consequently, the Government of X commits to accord all categories of bilateral and commercial creditors -and in particular creditor countries not participating in these Agreed Minutes, and private creditors- a treatment not more favorable than that accorded to the Participating Creditor Countries”. 3. In PC’s taxonomy, the consolidation period is the period during which debt service falling due (principal and interests) is restructured. It typically corresponds to the period of the IMF program, which must show a financing gap that can only be covered by debt rescheduling. 4. In some past cases, arrears accumulated as of the start of the consolidation period have been also treated. 5. “Exceptions can be made, for example, when the debt only represents a small proportion of the country’s debt burden and when restructuring would unduly interfere with the smooth running of trade.” (www.clubdeparis.org). 6. See the cases of Ukraine (2000), Pakistan (2001) or Jordan (2004). 7. Schlegl M., Trebesch C., Wright M., The Seniority Structure of Sovereign Debt (2019). CESifo Working Paper No. 7632, available at SSRN: https://ssrn.com/ab- stract=3387668. 8. Claw-back provisions are not included in PC’s MoUs. Therefore, the main disincentive for borrowing countries to breach CoT is the risk of jeopardizing the implementation of the IMF program, rather than the possible cancellation of the PC’s agreement. 9. These cases have raised the call for “reverse comparability” (i.e., PC accepting the terms of the private debt relief on CoT terms), which the PC has rejected. 10. For instance, in the case of Chad, the request for CoT is difficult to enforce, as the debt of the main commercial creditor (Glencore) is collateralized by oil revenues and has been regularly serviced EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 2 > > > F I G U R E 1 - Example of a Paris Club’s “flow treatment” Debt service to be rescheduled Rescheduled debt service compounded by creditor to achieve CoT by moratorium interest rate Total: 100M USD 0 15 30 45 60 0 15 30 45 60 Debt service to be rescheduled in the consolidation period* Assumption: USD 100 millions 100 ORIGINAL DEBT SERVICE 100 DEBT SERVICE AFTER TREATMENT 80 80 USD Million USD Million 60 60 40 40 20 20 0 0 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Consolidation period Creditor Committee (CC) Other bilateral Commercial * Calculated as the difference between the funding needs and the identified borrowing sources in the consolidation period EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 3 Main limitations of PC’s approach and proposed reforms This finding calls for a significant reform of the current As a result, the CF should consider joint (or at least CF process, which is based on a two-step approach i.e., simultaneous and coordinated) negotiations across first reaching a debt relief commitment from the Creditors’ key creditors.11 This is critical given the significant share of Committee (CC), then requiring the borrowers to seek relief commercial debt in CF’s eligible countries12 and the resulting from commercial creditors on the basis of CoT. The limitations lack of leverage of the official creditors over private creditors.13 of the current approach are the following: This reform can also help overcome the challenge of the a. It extends the length of the overall negotiation phase, as different definitions of official and commercial debt across private creditors are not given any indication of the CC’s creditors. At the minimum, the CC should be open to share restructuring terms until the terms are confirmed in the and discuss any relevant analysis (e.g., DSAs, calculation CC’s Memorandums of Understanding (MoUs). of the restructuring envelope, simulation of the restructuring b. It increases the likelihood of “light” restructurings (i.e., parameters) with commercial creditors as soon as they rescheduling of debt service with limited or no NPV become available. reduction) and consequently the recurrence of debt distress, as CC creditors are not likely to commit to a deep relief in the absence of any similar assurances from the private creditors. CoT based only on NPV reduction The challenge of identifying a methodology for assessing CoT b. It is relevant for both rescheduling (“flow treatment”) and remains even if the proposed simultaneous and coordinated restructuring with nominal haircut (“stock treatment”), as approach to debt restructuring were to be adopted. The broad- opposed to the other two indicators which could be used based and discretionary ex-post interpretation of CoT applied only to assess the former. thus far by the PC might have been driven by pragmatic c. It is not affected by duration-bias. On the contrary, motivations, but does not serve well the CF, given the higher setting a “consolidation period” for debt restructuring level of scrutiny and the severe reputational risk in case of makes the treatment dependent on the duration of the non-compliance. original claims (i.e., any principal payment falling beyond the consolidation period is not subject to restructuring). To assess CoT ex-ante, preference should be given to NPV d. It is widely used by financial market participants. In reduction among the three indicators currently used by the private restructurings, fair burden sharing is achieved by PC, as: targeting equal NPV reduction across the outstanding a. It captures the impact of changes in the other two instruments in the restructuring perimeter. indicators (i.e., changes in debt service cash-flows and duration extension). There are two methods of computing NPV reduction: 1. NPV reduction = 1 - PV of the new debt 2. NPV reduction = 1 - PV of the new debt FACE VALUE of the old debt PV of the old debt 11. E.g., committee representing Eurobonds’ investors or largest private sector creditors 12. In the case of Chad, Ethiopia, and Zambia, the ratio of commercial debt over bilateral debt is respectively 126, 77, and 141 percent (Source: International Debt Statistics, World Bank, 2022) 13. In Chad, assuming a 2022-2024 consolidation period, one creditor (Glencore) is expected to provide 80 percent of the debt relief in nominal terms, on the basis of the debt relief targets set by the creditors providing the remaining 20 percent. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 4 The difference between the two is the denominator (old debt), therefore their maturity profiles are no longer relevant. However, which in (1) is taken at face value, while in (2) takes into for the purpose of CoT between private and official creditors, consideration the debt’s redemption profile. equation (2) provides the most appropriate metric, as equation Equations (1) and (2) yield the same result for financial market (1) would unfairly over-value official claims (i.e., to achieve CoT, participants as a metric of cross-creditor comparability because the different level of concessionality of the original instruments bond/loan payments are typically accelerated at default and must be valued). Single discount rate to be used in CoT calculations The choice of the discount rate is crucial in the NPV calculation of providing a benchmark for comparability across private and involves some level of discretionality. However, assuming creditors (e.g., bondholders). Nevertheless, two caveats should that equation (2) is followed, the choice of the discount rate be raised: would only affect the contribution of interest rate reductions a. NPV reduction should be calculated on the entire debt relative to maturity extensions (nominal haircuts are neutral to stock for each category of creditors (as opposed to discount rates). In other words, the higher the discount rate, targeting only the debt falling due in the consolidation the higher the incentives for the creditors to achieve the same period). level of NPV reduction through maturity extension as opposed b. If any debt service were to be brought forward to a future to interest rate reduction. date (for instance, because of a standstill) the same discount rate should be used. This point would alter the In light of this, the use of “exit yields” (or a proxy for a post- PC’s practices of compounding rescheduled amounts at restructuring market yield, to be agreed upon during the discretionally defined “moratorium interest rate”. negotiation phase) is advised, as it has the additional advantage Conclusions This note proposes to replace the existing discretionary To be effective, this reform should also be accompanied by a methodology for CoT assessment with the single, transparent revision of the CF procedures to implement simultaneous and indicator of NPV reduction based upon a common discount rate coordinated negotiations across key creditors, as opposed to of the borrower’s “market exit yield” or a proxy of the cost of the current two-step approach. debt post-restructuring. EQUITABLE GROWTH, FINANCE & INSTITUTIONS NOTE <<< 5