Spring 2022 — Sovereign Debt Architecture, Suspended
A Proposal for a New Approach to African Debt

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May 20, 2022

Daniel Bradlow, University of Pretoria

The current sovereign debt architecture is failing African states in multiple ways. Among these, it fails to incentivize private creditors to be sufficiently flexible in dealing with sovereign debtors in difficulty. The presumption against providing adequate relief is built in even when the cause of sovereign debt problems lies beyond the debtor’s control and is resulting in terrible human suffering and economic damage.
African countries are facing difficult economic times. Over the next few years, they need financing to deal with a range of social and economic challenges. In addition to its health impacts, the COVID pandemic has increased hunger and unemployment in most African countries. These countries will also need funds to deal with climate change and the consequences of the war in Ukraine, which is adversely affecting the prices and supply of food, fertilizer and energy.
Official sources of funds will not be sufficient to meet all these needs. Therefore, African governments will need to utilize private funding sources. However, their access to international financial markets is uncertain. Already 22 low-income African countries  are either in debt distress or at high risk of debt distress, and a number of middle-income countries could have trouble meeting their debt obligations in coming years.
Unfortunately, their private creditors have not proven to be particularly helpful. Bonds denominated in foreign currencies constitute approximately 20% of the total stock of African sovereign debt. The holders of these bonds failed to participate in the limited debt service suspension initiative (DSSI) organized by the G20 in response to the COVID-19 shock, They have also not yet agreed to any debt or debt service relief in conjunction with the G20 Common Framework for Debt Treatments beyond the DSSI.
Mindful of this experience and Africa’s urgent financing needs, stakeholders in African debt should advocate for new approaches to managing distressed sovereign debt. In particular, they should seek to disrupt inter-creditor dynamics and create incentives for bondholders to be more open to innovative ways of delivering debt relief. They and their supporters need to do more than merely encourage Africa’s creditors to be more generous.
One way to change these inter-creditor dynamics is a DOVE (Debts of Vulnerable Economies) Fund. This fund would be established by public, private, and civil society stakeholders to invest in marketable foreign currency debt issued by African countries. By its mandate, the Fund would commit to participate in debt restructuring negotiations based on a set of guiding principles clearly articulated ex ante and grounded in applicable international standards. The guiding principles would be designed to ensure that the debt restructuring process is transparent and fair to all stakeholders, and that its outcomes promote socially and environmentally inclusive development in the debtor country.
One ancillary benefit of the DOVE Fund is its impact on potential vulture investors. The entry of the DOVE Fund into the market would be expected to cause the prices of the selected sovereign’s debt instruments to rise. This should act as a disincentive for at least some vulture funds to buy the debt with the intent of holding out and free-riding on the sacrifice of others.
The DOVE Fund’s Approach to African Debt
The DOVE Fund would only agree to a debt restructuring that has the following four attributes, further elaborated below:
• First, the restructuring process must allow for the participation of as many stakeholders in African debt as possible.
• Third, the restructuring must free up resources that, in fact, are invested into socially and environmentally sustainable development activities. It should include a monitoring mechanism to ensure that all parties to the transaction are accountable for their compliance with its terms.
• Fourth, the debt restructuring must preserve, as far as possible, the debtor’s access to international financial markets.
(1) Participation and Representation
The stakeholders in a country’s debt include that country’s citizens, the financial and non-financial entities that have invested in the country, the philanthropic foundations and international and national civil society organizations that are active in it, and the multilateral organizations and donor governments that provide it with financing and/or technical support. The DOVE Fund would utilize a range of instruments to attract this diverse group of investors.
It is important to recognize that the different groups of investors will have different motivations. Some investors, such as individuals and foundations, will be motivated primarily by the opportunity to promote more sustainable and fair approaches to African debt. These investors can be expected to invest through impact/pay for performance bonds. Other investors will be primarily concerned with maximizing financial returns—particularly if they have mandates to that effect, paying due regard to a responsible correlation between the risk and return.  These investors may be more interested in debt instruments that have formal repayment priority and a state-contingent repayment term, or a preferential instrument with a sub-market but fixed rate, on the expectation that they would benefit from improved business opportunities associated with the debtor’s economic recovery. All these investors may also prefer to make an equity investment in the DOVE Fund.
To achieve its objectives, the DOVE Fund would need to purchase sufficiently large stakes in its target countries’ bond stocks to influence restructuring negotiations. This would enable the DOVE Fund to be an effective advocate for a new approach to a particular country’s debt.  
The opportunity for these investors to promote a debt restructuring that is consistent with the applicable international standards will be further enhanced by the governance structure of the DOVE Fund. Its governing board should include representatives of all the different groups of stakeholders. The members of each category of stakeholder-investors will elect the directors who will represent that group of stakeholders. The structure of the board should offer all participating stakeholders a fair voice in the governance of the Fund. 
(2) Compliance with International Standards
The past two decades have seen the emergence of multiple codes of conduct, principles, norms, and standards that are applicable to sovereign debt management and debt crisis response. The DOVE Fund will use the most widely recognized of them to develop a set of principles that can guide its participation in restructurings and its requirements for restructuring outcomes.
Some of these standards, such as the above-mentioned IIF Principles and the UNCTAD Principles, highlight the importance of transparency in debtor-creditor relations. Their purpose is to encourage the debtor in distress to provide its creditors with full information at a meaningful time about its debts and their terms and conditions. In the context of the DOVE Fund this standard further suggests that the debtor, to the greatest extent possible, should be transparent with all its stakeholders.
Transparency provides all parties with important benefits. First, the   debtor, by providing all its creditors with the same information on all its outstanding debt obligations, can enhance each group of creditor’s confidence that the burden of the restructuring is being shared commensurably among all the creditors. Second, by making this information, subject to appropriate safeguards, publicly available, the debtor will help both the creditors and the other stakeholders in the country understand all the social, environmental, economic, and financial impacts of whatever debt restructuring is being proposed. This can help mitigate the risk that the restructuring inadvertently imposes unfair burdens on any particular group of stakeholders. Finally, it will enable the DOVE Fund to analyze the challenges that the debtor may be facing in complying with the principles and to make any appropriate adjustments.
Transparency will also enhance the ability of the individuals, foundations and philanthropies who are investors in the DOVE Fund to advocate for debt restructurings that are consistent with the DOVE Fund principles, by ensuring that they receive timely and accurate information. Their participation in the DOVE Fund and their expressions of their views on particular proposals will increase the profile of the debt restructuring and increase the reputational cost to those bondholders who are insisting on a tougher and less socially and environmentally inclusive and sustainable approach to the sovereign debt.
A second group of international standards relate more to the outcomes of debt restructurings These include the UN Guiding Principles on Business and Human Rights, the multilateral development banks’ environmental and social frameworks, and the Principles on Responsible Investing. While there are important differences among these standards, they all highlight the importance of exercising due diligence and undertaking impact assessments in advance of entering into any particular debt transaction, including a restructuring. These assessments should focus on all relevant environmental, social, human rights and good governance considerations.
In this regard, it is important to note that the sovereign debtor may have legal obligations to stakeholders apart from its creditors. The identified impacts of the proposed restructuring may be inconsistent with some of these obligations. There is no inherent reason that these legal obligations should be given less weight in the debt restructuring than the debtor’s contractual commitments to its creditors. The DOVE Fund would use its guiding principles to reconcile, balance, and prioritize competing demands on and obligations of the sovereign in debt distress.
Many international investors have endorsed a broad range of these international standards, and should be expected to abide by them in any debt renegotiation.
(3) and (4) Use of Proceeds and Post-Restructuring Market Access
The DOVE Fund must pay due regard to market dynamics in two respects. The first concerns the sovereign obligor whose debt instruments the DOVE Fund holds. The DOVE Fund would need to ensure that the terms of any debt restructuring, while providing relief to the debtor, also instill confidence in its creditors and other investors that the debtor’s financial situation will improve and its economy begin growing over the medium term. This should help encourage them to both participate in a restructuring that is consistent with the DOVE Fund standards and continue financing the debtor state after it recovers from the crisis.
The second aspect relates to the DOVE Fund’s investors. Since the Fund is explicitly designed to act as a participant in international financial markets, it must offer its investors the possibility of earning a return on their investment. This is feasible, because the DOVE Fund, consistent with the principle of maintaining market access, would be earning whatever interest and principal payments may be due on the financing instruments used in any restructuring. The DOVE Fund could also sell them at a profit in the secondary market. As a result, it would be in a position to provide returns to its investors. A debt restructuring that is consistent with the DOVE Fund standards and with restoring sustainable finances in the debtor state should improve the repayment prospects and marketability of the country’s debt instruments.
Africa is facing a complex mix of environmental, social, political and economic challenges. It is obvious that it has not yet found an effective way to meet these challenges. But it is also apparent that it cannot meet these challenges with a “business as usual” approach. Consequently, Africa and its stakeholders need to experiment with new ways of dealing with its problems, including its debt problems. The DOVE Fund is an example of such an experiment, using market mechanisms to encourage Africa’s creditors to support its efforts to find a sustainable approach to its many challenges.


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