Resolving Sovereign Debt: Collective Action Clauses or the Sovereign Debt Restructuring Mechanism

When sovereign debt restructuring or debt reduction becomes unavoidable, what is the appropriate regime that can provide for an orderly restructuring, while at the same time protecting the rights of both creditors and the debtor? The recent wave of sovereign default has underscored the limits of the current market-based regime. Recently two alternative approaches propose a contractual approach by way of the introduction of collective action clauses (CAC) in bond contracts, and a statutory approach put forward by the International Monetary Fund (IMF), which calls for the establishment of an international debt restructuring mechanism (called the sovereign debt restructuring mechanism or SDRM) that would have many of the features of an international bankruptcy regime. This paper assesses the two crisis-resolution mechanisms. It shows that although no consensus exists on whether the best approach about how to manage and resolve sovereign debt crises is to promote the use of collective action clauses, or to create a statutory mechanism, it is, nevertheless, evident that the SDRM is shelved for the time being. It examines the reasons for this, and argues that to the contrary, a complementary approach that combines elements of both the CAC and the SDRM (now proposed by the IMF) has the potential to help reduce the unacceptably large costs associated with disorderly defaults by sovereign governments whose debt burdens have become unsustainable