Reprofiling Today for a Sustainable Tomorrow: A Unilateral Italian Debt Restructuring

By Emma Cervantes, Victoria Dodev, Shane Ellement, Isabelle Sawhney (Duke University, School of Law)

Italy has €2.4 trillion of debt – an unsustainable level in pressing need of a restructuring. However, traditional avenues for sovereign restructurings cannot be utilized because Italy’s situation is complicated by several factors. First, the massive outstanding bond stock and diversity of bondholders makes a traditional consensual restructuring impractical. Additionally, about 68% of outstanding bonds are held by Italian parties, making any restructuring harmful to the domestic economy. To further add to this complicated situation, the ESM Treaty purports to impose additional restraints on Italy’s ability to restructure through the addition of CACs to approximately 60% of Italy’s bond stock.

Fortunately, there is a loophole in Italy’s bonds that can resolve these problems: Italy can unilaterally extend its maturities without bondholder consent. This power stems from the fact that Italy’s domestic government securities are issued as decrees under the relatively unknown 2003 Consolidated Act, which explicitly grants Italy the power to unilaterally extend bond maturities. Accordingly, 98% of its outstanding bond stock, about €2 trillion, can be restructured without bondholder consent. This strategy could result in the largest sovereign debt restructuring in history being done unilaterally.

This proposal demonstrates that the inclusion of CACs in some of its bonds does not foreclose the use of Italy’s Article 3 power. The proposal also describes the mechanics by which Italy would exercise its right to extend maturities. Unilaterally extending maturities does not require any retroactive utilization of the local law advantage. Nor does it expose Italy to significant legal risks in its domestic courts or under European treaties and conventions.

The full article is available here.

A Sovereign Debt Restructuring Framework for the Euro Area

By Sebastian Grund, Mikael Stenström (European Central Bank)

Our new paper discusses the legal framework for sovereign debt restructuring in the euro area – both de lege lata and de lege ferenda. Sovereign debt restructurings remain exceptional events that come with profound implications for financial stability and monetary policy transmission. However, they may be necessary as part of a financial assistance program to a euro area Member State, as was the case for Greece in 2012. Indeed, the European Stability Mechanism (ESM), the euro area’s lender of last resort to sovereigns, may only lend to countries with sustainable debts. Thus, if debt is assessed as unsustainable, an orderly debt restructuring may be warranted to allow for financial assistance by the ESM.

This paper seeks to contribute to the ongoing policy discussion on how to enhance the functioning of the Economic and Monetary Union (EMU) by exploring the legal aspects of sovereign debt restructuring in the euro area. Drawing upon the International Monetary Fund’s framework for debt restructuring, it analyses whether and how the procedures for sovereign debt restructuring in the euro area can be made more orderly, fair, and predictable by establishing a European Sovereign Debt Restructuring Framework (ESDRF).

We conclude that policymakers may consider the inclusion of enhanced Collective Action Clauses (CACs) as well as certain technical amendment clauses with a view at avoiding holdout inefficiencies. Indeed, the first version of the euro area CAC deviated from the international standard, as it did not allow for full aggregation of bondholder votes across all series. Thus, the euro area always faced a residual risk of holdouts blocking individual bond series, as was for instance the case for certain English-law bonds during the Greek debt restructuring of 2012. Besides CACs, we discuss the potential immunisation of ESM funds from holdout litigation as well as (temporary) stays on debt enforcement actions by opportune investors during restructuring negotiations, also taking account of recent innovations in the context of the Puerto Rican debt restructuring.  Finally, we review broader statutory changes to the current framework. Specifically, two options for a sovereign debt dispute resolution mechanism are discussed: (i) a separate chamber at the Court of Justice of the European Union (CJEU) and (ii) a sovereign debt arbitration mechanism. The rationale behind the establishment of such tribunals would be to centralise dispute settlement in the context of sovereign debt restructurings, thereby forestalling negative externalities from fragmented judicial decisions on bondholder claims.

The paper makes no judgement on the economic or political feasibility and necessity for such changes, but seeks to contribute to the debate by shedding light on the legal aspects to be taken into account in the context of completing Europe’s Economic and Monetary Union.

The full article is available here.