CHAPTER 6

Essential Reform of the International Financial System: Collective Action Clauses

These three items trace out one of the most interesting and surprisingly rapid reform efforts in the history of the international financial system. For years, experts in international finance had argued that a more predictable and systematic procedure for restructuring a country’s international debt was essential for preventing financial crises. Many crises in the past occurred when countries reached unsustainable debt positions and seemed to have no choice other than a volatile and chaotic default to its creditors or a large influx of funds from the official sector, which would in turn have their own disincentive effects . One proposed reform would be to incorporate special clauses (sometimes called collective action clauses) in the country’s bonds to describe how a country would work with its creditors to restructure its debt (economist Barry Eichengreen of Berkeley, for example, was a proponent). Another, more centralized approach was to create a new international bankruptcy court which would decide when and how the debt should be restructured.

As part of a broader effort to reform the international financial system, the Bush Administration decided in 2001 that the time had come to actually implement such a sovereign debt reform. (The continuing crisis in Argentina reminded everyone of the importance of implementing such a reform, for if such a reform had been in place, many argued that the Argentine situation would be much more benign). The Bush Administration—after careful legal and financial analysis at Treasury (not only International Affairs, but also General Council, Domestic Finance, Economic Policy)—decided that the decentralized approach would be the better reform and would have a much better chance of being implemented. It could provide many of the advantages of the centralized approach without creating a new international organization, relying more on the private sector than on government. Others—including the staff of the International Monetary Fund—thought that the centralized approach would work better. And there was considerable public debate.

The first item in this section summarizes the Bush Administration’s proposal as put forth publicly in a speech I gave in April 2002. We knew that implementing this proposal would require a great diplomatic effort because there was resistance from borrowing countries, who thought that the clauses would raise their borrowing costs, and from the New York investment banking and legal community, who saw it as a costly change in their template for issuing bonds. The existence of an alternative proposal advocated by the IMF (and in particular by my colleague Anne Krueger) also had bearing on our financial diplomacy plan. My April 2 speech (and many others) was an exercise in persuasion.

The second item in this section was a speech given eight months later after much heated debate in the press and in the international financial community. The speech was given in New York before the Emerging Market Traders Association. It too was an exercise in persuasion, addressing the concerns that had been raised with our proposal during the previous eight months of discussion. I went out on a limb in that speech and called for 2003 to be the “Year of the Clauses,” recognizing that there were still many skeptics. In the meantime, less public efforts were under way to persuade emerging market governments to issue bonds with the new clauses, and to ask other G7 countries to join in the diplomatic effort. In the end, 2003 did become the year of the clauses. A real break-through occurred in March when Mexico decided to show real leadership and issued debt in New York with collective action clauses; it was a great success—a low price and a high participation. Many other countries followed suit.

The third item simply reports on the amazing progress during the year. By then, bonds with the new clauses had become the standard template for the investment banking and the legal community. A difficult, but important, reform had been implemented.

1. Sovereign Debt Restructuring: A U.S. Perspective, Institute for International Economics, Washington, D.C., April 2, 2002

2. Using Clauses to Reform the Process for Sovereign Debt Workouts, Emerging Markets Traders Association, Annual Meeting, December 5, 2002

3. Decisions by Countries to Issue Bonds with Collective Action Clauses (CACs), February 3, 2004