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Tuesday, January 31, 2023

Debt restructuring for dummies – The Morning

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  • Advisors appointed, what’s next? 

After facing delays due to the lack of a Cabinet of Ministers, the Sri Lankan Government last Tuesday (24) announced the appointment of debt advisors Lazard and Clifford Chance to restructure its recently defaulted debt. Swift appointment of debt advisors was a key proposal suggested by economists, corporate leaders, and business chambers to resolve Sri Lanka’s unprecedented economic crisis. 

Market Mine this week will detail what this appointment means for the Sri Lankan economy, what will happen next, how the debt will be restructured, and a number of other potential questions that the general public might seek answers for. 

 

What do debt advisors do? 

 

In general, debt advisors help clients find ways to repay debt affordably and provide advice on dealing with the impacts of debt. In simple terms, debt advisors help restructure debt. 

According to Investopedia, debt restructuring is a process used by companies, individuals, and even countries to avoid the risk of defaulting on their existing debts, such as by negotiating lower interest rates. Debt restructuring provides a less expensive alternative to bankruptcy when a debtor is in financial turmoil, and it can work to the benefit of both borrower and lender.

Sri Lanka is not the first country to default and restructure its debt, as countries like Argentina and Ecuador are popular examples of this move. However, the roles of these debt advisors might change when it comes to restructuring the debt of a country, particularly a country like Sri Lanka that is mired in massive debt, higher than its Gross Domestic Product (GDP). 

 

Who are Lazard and Clifford Chance? 

 

Lazard is one of the debt advisors appointed by the Sri Lankan Government to restructure its debts. Lazard Ltd. is a financial advisory and asset management firm that engages in investment banking, asset management, and other financial services primarily with institutional clients. It is claimed to be the world’s largest independent investment bank, headquartered in Bermuda with principal executive offices in New York, Paris, and London. 

In July 2020, Reuters reported that Lazard’s team of 20 sovereign specialists had been hired by Zambia and Ecuador as debt advisors. UK’s Financial Times in May 2020 stated that Lazard was expected to advise on restructuring the cash-strapped southern African nation of Zambia’s $ 11 billion foreign debts that have threatened to become Africa’s first sovereign default during the Covid-19 pandemic. The investment bank was hired on a $ 5 million contract to advise on ‘liability management’ of the country’s debt after a tender process.

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Clifford Chance LLP is an international law firm headquartered in London, UK, and a member of the ‘Magic Circle’ – a group of London-based multinational law firms. It ranks as one of the top 10 largest law firms in the world measured both by the number of lawyers and revenue. 

In 2020, Clifford Chance advised the Argentina Creditor Committee (ACC) on the successful restructuring of approximately $ 65 billion of eligible bonds by Argentina. This historic and complex sovereign debt restructuring, a critical step towards the recovery of Argentina’s economy in the midst of the Covid-19 pandemic, achieved overall participation of 93.55% of all eligible bonds, resulting in a total of 99.01% of eligible bonds being restructured pursuant to collective action clauses under two indentures and across multiple series. 

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What will they do in Sri Lanka? 

 

Speaking to The Sunday Morning Business, Advocata Institute Chief Operating Officer (COO) Dhananath Fernando said that now that debt advisors had been selected, the Sri Lankan Government would enter into a contract with these advisors. After the Government makes the initial payment to these advisors, the restructuring process would commence, Fernando stated. 

“When the payments are made, debt advisors will start the process which includes a background check, analysing the statistics, evaluating all the bond agreements and pertinent available documents, while on the other hand, a legal team evaluates bond contracts,” he explained. 

According to Fernando, simultaneously, the debt advisors would join the International Monetary Fund (IMF) to undertake debt sustainability analysis and coordinate with Sri Lankan bondholders’ legal and financial advisors in doing so. 

Bondholders who are also referred to as investors of Sri Lankan bonds appear to have already appointed financial advisors from their end, and one of these advisors is Rothschild & Co, a France-based investment banking company. 

“Once evaluation of debt is done, both the parties (debt advisors and bondholders) will negotiate and discuss how their debt can be restructured. This will be a complicated process and many technical tools will be involved,” he added. 

Fernando stated that there were several ways Sri Lanka could go for debt restructuring. They are:

  1. Sovereign bondholders have to take a haircut by agreeing to accept a reduced percentage of what they are owed, perhaps 25% of their bonds’ full value 
  2. The maturity dates on bonds can also be extended, giving the Government issuer more time to secure the funds it needs to repay its bondholders
  3. Coupon clipping which refers back to a time when these fixed-income securities came printed with coupons on them. To receive the interest payments, the bondholder would clip off each coupon as its payment came due and redeem it for cash
  4. A mix and match of the aforementioned options 

 

What are the complications related to this process?

 

Fernando stated that even though Sri Lanka had single-handedly decided to default and restructure its debt, not all public debt had been suspended as per the statement issued by the Ministry of Finance on 12 April, announcing the debt default. 

He added that Sri Lanka Development Bonds (SLDBs) were not covered under this default, and therefore, SLDB debt had to be taken out of debt negotiations.

“Details of most of the debt are not yet disclosed. There is a lot of public enterprise debt and some of these are dollar-denominated debts. Details of these debts have to be disclosed. In addition to this, some banks are holding International Sovereign Bonds (ISBs) and SLDBs. Even though these bonds have reached maturity, we have no dollars to repay them,” Fernando stated. 

Fernando warned that the discussions would be ‘very complicated,’ ‘very technical,’ and ‘very painful’ for everyone involved in the process. 

According to him, the IMF would have a role in the discussions as it was identified as the only independent agency with information on debt sustainability analysis while also being trustworthy. He added that the IMF would devise a financial programme with which Sri Lanka would be able to move forward along with the restructuring process.

Attorney-at-Law and University of Colombo Faculty of Arts Department of Economics Senior Lecturer Grade II Dr. Shanuka Senarath told The Sunday Morning Business that even for Sri Lanka to negotiate during the restructuring period, it should have a method of payment, meaning that an income should be present to show the debt advisors that it had ‘something’ to pay with.  

“How much can we pay is the question. We cannot pay, but ideally, we should have a minimum ability to pay. We do not have money to pay even for a fuel shipment. IMF is a platform where Sri Lanka can do the negotiation. This Government has zero ability to manage the debt,” he added. 

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How long will debt restructuring take? 

 

The debt restructuring process is expected to be time-consuming and may or may not take more than one year to complete, given Sri Lanka’s large debt stock.

As Fernando notes, Sri Lanka has multilateral debt, bilateral debt, as well as private debt, and amongst these, multilateral debt and bilateral debt are difficult to restructure.  

“Countries like Japan have their own guidelines on negotiations and then there are countries like China and India whose debt has to be negotiated separately. Bondholders too have to have a separate negotiation and restructuring,” he explained. 

However, last week, during an event in Colombo, Central Bank of Sri Lanka (CBSL) Governor Dr. Nandalal Weerasinghe stated that the country’s debt restructuring process could take about seven months. 

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Can Sri Lanka borrow during the interim period?

 

In Fernando’s opinion, in an instance where there is an ongoing restructuring process and creditors nations’ previous loans to us are being restructured, these countries might be reluctant to lend more to Sri Lanka given the instability the country is facing. 

“When debt restructuring is initiated, lenders might feel some assurance in the negotiation process but it all depends on how it moves. If the bondholders have a very negative experience in this restructuring process, they will quote very high prices for the next bonds. The interest rate will be very high because they know that Sri Lanka did not treat the bondholders well if the haircuts for the restructuring are harsh,” Fernando noted. 

Dr. Senarath stated that with the IMF backing Sri Lanka, lenders might become ‘happy’ to negotiate. However, Sri Lanka should not expect loans from the IMF to repay its debts. 

“What the IMF will do is give us a maximum of $ 4-5 billion to meet our balance of payments issues and Sri Lanka cannot utilise it to repay debts. This might be helpful in importing fuel,” he added. 

According to him, the sooner the restructuring works, the earlier Sri Lanka will be able to seek more loans as the country is considered bankrupt due to non-payment of debt and not having a restructured plan to make payments. He stated that when restructuring happened, it sent a signal to capital markets that Sri Lanka was not bankrupt although payments were delayed.  

He noted that while India might continue lending to Sri Lanka as usual, it would be ‘unlikely’ for Sri Lanka to get loans during the restructuring process unless it was a bilateral loan. 

“Just because you are in negotiation, that does not mean you are positive in capital markets,” he explained.  

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