Solving global debt crises, involving private creditors – the role of national legislation in G7 countries

‘The problem today is that we face major challenges in many respects that rely on a financially sound and solid state. And that financial soundness and solidity depends on a very small group of a relatively rich investors from relatively few industrialized countries.’

Matthias Goldmann

The COVID-19 pandemic has underlined the need for a financially sound and solid state. At the same time, it has also further fueled the global debt crisis. Currently, 135 out of 148 countries in the Global South are critically indebted (Global Sovereign Debt Monitor, 2022), three times as many as countries as before the pandemic. The repercussions of the Russian invasion of Ukraine and the global interest rise will further exacerbate debt crisis risks in countries of the Global South. Private creditors hold more than 60 per cent of all claims on countries in the Global South. In order to reduce debt in critically indebted countries, their participation in debt relief is therefore crucial. However, during the Corona pandemic, private creditors successfully refused to participate in debt relief.

Most of the international bond contracts are concluded under London or New York law. Therefore, G7 countries have both the opportunity and the responsibility to agree on measures and targets that can guarantee the binding inclusion of private creditors. Government representatives of the G7 – including the German government – recognize that the non-participation of private creditors is one of the main obstacles to resolving the debt crisis. They, therefore, insist on equal participation of private creditors in debt restructurings so that public concessions under the G20 Common Framework do not finance the bail-out of private creditors. But instead of using their powers to legislate, they are relying unilaterally on and so far with little success on "moral persuasion".

The German G7 Presidency in 2022 comes at an important point in time when decisive steps can be taken towards effective and comprehensive debt restructurings. One of the proposals by different actors including civil society organizations is to introduce national legislation in G7 countries that make it impossible for private creditors to undermine multilaterally agreed debt restructuring.

To push for a stronger public debate on binding rules for more efficient debt restructurings, the Friedrich-Ebert-Stiftung (FES) and the German Debt and Development Coalition Jubilee Germany have published two videos with renowned experts in the field of sovereign debt: Lee C. Buchheit (debt expert with more than 40 years of legal practice in sovereign debt restructurings), Anna Gelpern (Georgetown University) and Matthias Goldmann (EBS University Wiesbaden). They focus on why and how we have to move to action in order to shape comprehensive sovereign debt restructurings, and outline what role national legislation created and implemented in G7 countries can play to involve private creditors.

As Anna Gelpern states:

‘Right now, we have a system where a country at its worst moment is responsible for basically coordinating all of these people who have no incentive to write off their claims. That’s a little upside down, isn’t it?’

According to Buchheit, Gelpern and Goldmann, in the absence of international insolvency mechanisms, anti-holdout laws at the national level can play an important role in making debt restructurings more effective, compelling private creditors to participate in debt restructurings. While one expert sees potential risks, others think it is possible to overcome those and is rather based on the lack of political will.

Effective anti-holdout laws could have several faces. First, the legislation could codify that potential recovery of claims is limited to an equitable proportion to creditors that participated in a debt restructuring. An example is the UK Debt relief Act which applies to countries that benefitted from the “heavily indebted poor countries (HIPC) initiative”. Secondly, a law could shield payment systems. The third proposal is to limit the enforcement rights of private creditors by shielding government assets from creditor enforcement (i.e. asset immunity). Another was about codifying that creditors must cooperate in good faith.

Highly indebted countries do not generate enough income to pay interest and principles and continue to borrow to make repayments, and the total amount of external debts continues to rise. Systemic and structured debt resolution mechanisms are the sole way to address this situation. Well-capitalized private sector institutions, however, are committed to maintaining this unsound financial system.

Actions must be taken now. Key challenges such as energy insecurity and climate change, as well as the great scourges of humanity such as poverty, disease and inequality, could only be addressed with a financially sound and solid state. Germany, as the G7 Presidency this year, plays an important role in moving the agenda forward.

As Lee C. Buchheit points out:

‘G7 countries would have a powerful role to play if they could come up with a common approach to anti-holdout laws.’