Introduction
This paper examines state-contingent debt instruments (SCDIs) in sovereign debt restructurings, with a particular focus on value recovery instruments (VRIs). This technique provides additional recoveries to creditors if the debtor’s capacity to pay exceeds that assumed by the parties at the time of the restructuring and, in appropriate cases, could also be used to reduce or delay recoveries if the debtor’s financial situation worsens. This report examines the potential advantages and disadvantages of SCDIs, while highlighting the real-world challenges that need to be addressed if SCDIs are to become more effective and widely used tools of sovereign debt management.
After considering the potential benefits and drawbacks of these instruments, and evaluating their evolution over the last several decades, this report provides recommendations for their improvement. In particular, the Sovereign Debt Working Group recommends improving the integrity, effectiveness, and marketability of these instruments by:
- improving their design to ensure that the trigger events and formulas used for adjusting payments will, in fact, capture and measure cash flows that are directly available to the sovereign to service debt at the time it becomes due;
- maximizing the upside potential of VRIs by embedding them into underlying fixed income bonds, so that the combined instrument is more liquid and more likely to be included in bond indices (thus supporting active trading);
- providing for downside as well as upside adjustments to a debtor country’s payment obligations in specified cases of underperformance, which is only possible if the VRI is incorporated into the fixed income instrument that is the basis of creditor recoveries;
- ensuring that payout formulas and payout caps preserve positive incentives for the debtor and reduce the risk of bad behavior;
- creating a market environment (through various mechanisms) to promote broader and easier valuation and benchmarking;
- standardizing documentation; and
- encouraging more collaboration and earlier discussion regarding the design, potential use, and implications of VRIs between the public and private sectors both during the debt restructuring process and outside of it, and greater utilization of VRIs by the official sector in their own sovereign lending practices.
The report also includes more detailed case studies of VRIs issued by Mexico, Argentina, Greece, Ukraine, Puerto Rico, Suriname, and Sri Lanka.
