The 2014 World Economic Forum (WEF) Annual Meetings in Davos, Switzerland, were a testament to the fact that live, in-person interaction is still a necessary complement to remote, decentralized and virtual connections. Titans of business, heads of government and policy mandarins huddle in this remote ski town every year because they know they can accomplish more in a few days clustered in close proximity to each other than they can in months of travel or video conference calls.
Given the concentration of leadership, wealth and political capital at Davos, op-eds proliferate in the wake of the annual meetings that aim to take the temperature of global economic sentiment, identify emerging trends and anticipate prospective threats based on the formal discussions and happenstance hallway meetings that take place there. This commentary, however, reports on a much narrower slice of the action at Davos — The Centre for International Governance Innovation’s (CIGI’s) activity in the Swiss Alps last week.
This year, CIGI went to Davos with a specific agenda on two issues — sovereign financial distress and Internet governance — both of which directly affect Canada’s relationships with the world. CIGI’s engagement at Davos demonstrated the contributions a middle power such as Canada can make to the continued refinement of the architecture of the international system through informal fora such as the WEF.
First, CIGI held a round of consultations with capital markets participants and policy makers on ways in which the world can improve its approach to handling episodes of severe sovereign financial distress. The talks, organized in my capacity as a WEF Young Global Leader and a CIGI senior fellow, focussed on three sets of potential reforms: initiatives that could dampen the tendency of troubled sovereigns to delay seeking help when they run into financing problems; changes that could ease the resolution of sovereign crises once they break out; and finally, modifications to the international financial architecture that will help to implement sovereign bailouts once terms have been agreed.
The International Monetary Fund (IMF) observed in an April 2013 paper (IMF 2013) that when sovereign governments get into financial trouble, they tend to wait for a miracle, hoping a crisis will pass, and when it doesn’t, they tend to seek help at a late stage when the range of options available to resolve the situation has narrowed and become more costly. In short, as the IMF noted, when countries get into financial trouble, they tend to restructure their debt “too little, too late.”
A proposal to create a Sovereign Debt Forum (SDF) that would address the problem of too little, too late by reducing the impediments that sovereigns face in meeting their financing challenges head-on was put forward in a CIGI policy brief that I co-authored with CIGI Senior Fellow Richard Gitlin. The SDF would provide a standing venue in which sovereign debtors and creditors would meet on an ongoing basis to exchange information, refine common approaches to dealing with sovereign distress, monitor incipient sovereign financing crises, and segue to crisis prevention and resolution when financial stress in an individual or group of countries threatens to spike. The SDF would aim to dampen the “trigger problem,” wherein a government is reluctant to seek support from the IMF and other official institutions, fearing it would bring on the very crisis the request was meant to prevent or remediate.
Participants in our talks saw merit in the SDF as an addition to our international tool kit for crisis prevention and resolution as it would reduce the upfront costs of addressing a sovereign crisis before it has taken on full steam — unlike other major reform proposals currently in this space, most of which focus on making crises easier to handle once they’ve broken out or are in the midst of a resolution. The SDF would complement existing processes and bodies, and given its simplicity, its establishment would not require a negotiated international treaty or revisions to the charter of any existing international organization. The failure of the US Congress to ratify a major reform to the voting power and capital shares of the IMF on January 15 demonstrated the near futility of pursuing any reform proposal that requires a treaty agreement subject to US congressional approval.
The discussions in Davos echoed a few concerns about the SDF proposal that had been raised in consultations held over the last few months. Some policy makers were wary of adding another layer to the international financial architecture, while others questioned if reduced restructuring costs were sufficient incentives to bring all parties to the SDF table. Some market participants contended that debt restructurings already proceed on a fairly rapid basis, while, in contrast, some creditors and policy makers echoed Petros Christodoulou, former head of Greece’s public debt office, who noted to the Financial Times that, “The system needs to be fixed. We should have a predictable framework for restructurings that ensures that other countries do not have to go through what Greece did.”
There was also broad support in our discussions for a set of reforms, all complementary to the SDF, that would introduce automatic standstills in debt payments when countries run into trouble, and another collection of proposals that would refine the model language in bond contracts to make them easier to restructure once creditors and a debtor have agreed on the terms of a debt treatment.
On payment standstills, the Bank of Canada and the Bank of England have jointly drafted an excellent proposal on Sovereign Default and State-Contingent Debt that calls on major industrialized and emerging countries to begin issuing so-called “sovereign CoCos” (i.e., state-contingent convertible bond contracts) and macro indicator-linked debt. Bonds that feature CoCo provisions would see their maturities extended whenever a country seeks help from official creditors such as the IMF. Since most sovereign bonds these days are “bullet bonds,” bonds whose entire principal comes due at maturity, activation of CoCo clauses could give a sovereign substantial breathing room to sort out its financial affairs when experiencing periods of distress. CoCos would be complemented by other debt instruments whose payments would be tied to changes in macro indicators such as GDP, commodity prices or other major determinants of a country’s economic health. In short, payments would rise in good times and fall in bad times, giving a country a natural cushion against slipping into insolvency. CoCos and other state-contingent debt are natural complements to the SDF because they would provide breathing space for a distressed sovereign and its creditors to explore options under the SDF’s processes.
Davos participants were also keen to discuss how our SDF proposal would augment efforts underway by private and public stakeholders in the sovereign debt market to refine the model language of sovereign bond contracts to address a few specific weaknesses that have surfaced in recent years. First, recent court decisions in the US have created the possibility that dissatisfied creditors can reopen settled debt restructurings based on the “pari passu” provision in most bonds that requires equal treatment of all bondholders. Second, the Greek restructuring in 2012 showed that there are still serious deficiencies in the ways bondholders are asked to vote on the terms of a proposed restructuring. Under the current, market-based approach to restructuring debt, a supermajority of a single bond series’ holders must agree to terms before it can be restructured — a process known as aggregation wherein, say, 66 percent of a bond series’ holders are able to impose restructuring terms on all holders of the bond. If an individual bond series is small, it becomes relatively easy for a limited group of investors to block the restructuring of this debt by acquiring a minority share in it at a steep crisis-induced discount. In Greece’s case, about half of its foreign-law bonds could not be restructured as a result of such action. Future aggregation clauses will likely eschew individual bond series aggregation for a requirement of a supermajority across all debt holders. In exchange for this erosion of creditor rights, private-sector participants in our Davos talks indicated that they would likely be satisfied with a pre-commitment by sovereigns to engage in meaningful negotiations with creditors and perhaps pay creditors’ negotiating expenses while also ensuring enhanced transparency in the provision of government data.
Initiatives to begin issuance of sovereign CoCos and bonds with better contractual provisions are germane to our SDF proposal because they don’t require any kind of international agreement in order to move ahead, though even an informal consensus amongst some key sovereigns would help to ease market reception of these changes. Several Davos participants saw good prospects for some movement on refinements to the contractual language of bond contracts before the end of 2014. Action on an SDF and sovereign CoCos appeared less likely in the immediate term as the G20 has indicated it will await guidance from the next IMF board paper in this area, which is expected in June 2014.
Second, on January 22, CIGI joined with British think tank Chatham House to launch the Global Commission on Internet Governance (www.ourinternet.org), which will be chaired by Sweden’s Foreign Minister Carl Bildt. The Commission is a two-year initiative that will produce a comprehensive stand on the future of multi-stakeholder Internet governance.
The Commission, composed of about 25 members from various fields around the world, will encourage globally inclusive public discussions and debates on the future of Internet governance through a public consultation platform, as well as other institutional, media and academic channels. It will create and advance a strategic vision for the future around four key themes: enhancing the legitimacy of Internet governance; stimulating innovation; ensuring human rights online; and avoiding systemic risks.
The vision crafted by the Commission will serve as a rallying point for states that are striving for a continued free and open Internet. Davos provided an apt launching pad for the Commission’s work given the WEF’s confluence of Internet pioneers, lawmakers, net activists, social entrepreneurs and tech start-up hopefuls.
Among others, Canadian Foreign Minister, The Honourable John Baird, welcomed the Commission as “timely and important,” and underscored its relevance a few days later when he spoke in a major panel discussion on cyberwarfare and the potential to use the Internet as a tool for democracy promotion.
With debt burdens at very high levels across the industrialized world and capital retreating from emerging markets as the United States begins its long-awaited tapering of its exceptional monetary stimulus, sovereign debt restructuring is unlikely to lose relevance any time soon. Similarly, the rise of Bitcoin as the first online, anonymous bearer asset and costless payment system implies that Internet governance will be an issue that touches everyone’s lives with ever-greater political resonance. At Davos this year, CIGI helped Canada have a voice in shaping both issues.
IMF. 2013. “Sovereign Debt Restructuring: Recent Developments and Implications for the Fund’s Legal and Policy Framework.” IMF Board Paper, May. Washington, DC: IMF. www.imf.org/external/np/pp/eng/2013/042613.pdf.