How a New York State Bill is Shaping the Global Debate on Sovereign Debt
In March, New York lawmakers submitted the “Sovereign Debt Stability Act” to the New York State Assembly with the goal of “providing effective mechanisms for restructuring sovereign and subnational debt.” Proponents of the bill will seek to move it through both chambers of the legislature and receive a signature from the governor prior to the end of the legislative session on June 6.
While it may seem surprising that a state legislature is the scene of a globally significant policy debate on sovereign debt, New York law governs 52 percent of global sovereign bonds. This is particularly important as private creditors have come to play an increasingly important role in lending to developing countries: in 2021, 62 percent of developing countries’ external public debt was owed to private creditors. Yet, there are limited mechanisms to bring these creditors to the negotiating table in the case of restructuring.
Private creditors did not participate in the Group of 20 (G20) Debt Service Suspension Initiative, while the G20’s Common Framework has faced significant difficulties in bringing private creditors to an agreement and enforcing the comparability of treatment principle, which is meant to ensure equitable treatment between all groups of creditors. The sheer number of private creditors—thousands may hold pieces of a single country’s debt—also complicates restructuring negotiations.
Further, even when most creditors see the need for restructuring debt, agreements can be derailed by holdout creditors, including so-called “vulture funds,” which buy up distressed debt at low prices and then sue for the full value of the claims. Although the growth of collective action clauses—which enable bond restructuring if a supermajority of bondholders agree—has limited the influence of such holdout creditors, such clauses do not capture all debt.
Although bodies like the G20, Paris Club, International Monetary Fund and World Bank hold significant sway over public and multilateral creditors, they lack legal authority over private creditors and are forced to rely on voluntary measures when restructuring challenges emerge. New York State does not face that constraint. And because New York accrues the benefits from being a central market for sovereign debt, it has a responsibility to ensure an orderly and responsible market.
Here’s what the Sovereign Debt Stability Act would do and why some potential unintended consequences are unlikely to bear out.
What is the Sovereign Debt Stability Act?
The Sovereign Debt Stability Act, which combines elements of past bills, would provide indebted states with two options for relief. The first option would ensure comparability of treatment. In this scenario, if a private creditor sought repayment, there would be an upper bound on the private creditors’ claim, placing it at the same level at which public creditors would recover – in this case, “up to the proportion of the eligible claim that would have been recoverable by the United States federal government under the applicable international initiative if the United States federal government had been the creditor holding the eligible claim.” This is important because current negotiations with public and private creditors are largely independent, which means that comparability of treatment across public and private creditors is very difficult to ensure.
In the second option, indebted countries could elect to use a process somewhat similar to bankruptcy proceedings, which otherwise do not exist for sovereign states. In this process, which would be overseen by an appointed “independent monitor,” the borrower would submit a restructuring plan to its creditors. If each class of creditors approved the plan—requiring approval from holders of two-thirds of claims in amount and a majority of claims in number—it would become binding.
The two-part nature of the bill is slightly unwieldy—it ensures one route would survive if a court strikes down either the comparability of treatment or the independent monitor route, but it forces countries to choose one of two options that serve somewhat distinct purposes—and some of the details of these mechanisms would have to be ironed out through regulations and judicial interpretation. However, it provides greater clarity and enforceability than the current ad hoc approach to debt restructuring. The presence of defined paths to debt restructuring would prevent drawn out negotiations, and both debt relief options would protect governments and creditors alike from holdout creditors. The bill lacks clear definitions of some important terms, but this could facilitate deference to prevailing international standards rather than risking clashes between international standards and New York’s statutory definitions.
Why certain unintended consequences are unlikely to arise
Although the bill has substantial support, it also has faced a range of critiques arguing that, rather than achieving its aims of orderly sovereign borrowing and protecting taxpayers, it could generate some unintended consequences. Two of those critiques deserve particular attention. First, critics argue investment will simply move from New York to other jurisdictions in an effort to avoid legal uncertainty and reduced recovery costs, rendering the effect of the law moot and eroding New York’s status as a center for sovereign bonds. Second, critics argue that the bill will lead to increased borrowing costs for developing countries as investors increase risk premia.
To the first, there is little risk of investors moving existing bonds to other jurisdictions because it is unlikely the relevant parties would consent. For future bond contracts, the risk is plausible but still unlikely. The factors that have made New York law appealing—including the quality of its courts, the size of its financial sector and investors’ familiarity with New York—will remain. And while potential legal uncertainty created by New York’s new law is cited as the reason investors might start issuing bonds under other the law of other jurisdictions, this overlooks that investors would face a whole new layer of uncertainty in subjecting themselves to new legal regimes where they have little history of issuing sovereign bonds. Indeed, past innovations in sovereign bonds, like the advent of collective action clauses, did not lead to major capital flight.
To the second critique, there is also good reason to think that borrowing costs will not rise as a result of this bill, as it will correct important flaws in the sovereign debt market. The bill offers real benefits to many creditors, namely reducing the power of holdout creditors. Faster negotiations will allow indebted countries to return to stable growth trajectories more quickly, increasing their capacity to repay and allowing bonds to trade in the market again once a deal is struck. The example of collective action clauses is also instructive here: despite criticisms that they would increase borrowing costs, this has not taken place, with investors finding greater predictability in restructurings more important than unimpeded latitude to pursue claims. Further, it is rare for sovereigns to default and rare for private creditors to suffer significant losses. If investors did raise borrowing costs, it would largely reflect the extent to which their returns rely on securing more profitable restructuring deals than public creditors—and if markets are currently reflecting failures to enforce comparability of treatment, those inconsistencies need to be corrected.
To be sure, it is entirely appropriate to analyze the Sovereign Debt Stability Act for potential risks, and while the bill would bring greater certainty in the medium- to long-term, all policy changes bring some initial uncertainty.
But if the evaluation of the bill’s risks is to be balanced, it must place the risks of the status quo on the other side of the ledger. Zambia has been stuck in debt restructuring negotiations for over three years, while other countries with unsustainable debts delay necessary restructuring because the travails of countries like Zambia are so unappealing. Private creditors declined to participate in the Debt Service Suspension Initiative, and when they have participated in restructurings, they have repeatedly proposed restructuring deals that would impede future debt sustainability and come at the cost of public creditors.
As they consider the merits and risks of this bill, New York legislators would be well-advised to consider the inadequacies of the current global sovereign debt architecture, too.
*
Never miss an update: Subscribe to the Global Economic Governance Newsletter.