Debt restructurings get more rational, but private lenders are still groping in the dark

The sharp rise in interest rates since 2022 has put the debt positions of many emerging market sovereigns under pressure. A few defaults followed, although there was not the wave some had predicted.

Ghana completed a restructuring this month and Sri Lanka came close to a conclusion, following successful deals for Ukraine over the summer and Zambia earlier in the year. Negotiations took a long time, particularly in Zambia, where they lasted over three years.

“We have a healthier asset class now,” says Kaan Nazli, senior economist and EM debt portfolio manager at Neuberger Berman in London. “Looking at some sovereigns, there was an assumption early in 2024 that if we had another year like 2022 then they were in line for a restructuring.”

There are still sovereigns in default, including Lebanon, Ethiopia and Venezuela, the last of which has tens of billions of dollars of Eurobonds.

“What we hopefully see is another wave of negotiations in places which are still in default,” says Marten Bressel, EM fixed income portfolio manager at FIM Partners in London. “It’s unlikely we’ll see another wave of sovereigns going into default.”

Positives in recent restructurings have been a wider role for the International Monetary Fund, a degree of consensus between traditional and new investors and the development of variable rate instruments to bridge gaps.

But there are still headaches — particularly over transparency and the comparability of treatment of different creditor classes. And in every process there are always disagreements that are difficult to predict.

The G20’s Common Framework for Debt Treatments, set up in 2020 to speed up debt restructurings, has come under fire because of the still long time restructurings under it are taking, epitomised by Zambia’s three and a half year struggle.

A principal problem has been reconciling ‘traditional’ EM lenders, such as Western nations and private creditors, with new faces, especially creditors from China. The latter have pushed back on many of the conventions of debt restructurings.

In Zambia’s negotiations, Chinese creditors proposed that multilateral lenders like the IMF take haircuts on their debt. This was never going to happen and it delayed the process by months.

But what the Framework has done is bring together creditors, such as the Paris Club and those in China, who had had very little, if any, experience of carrying out debt talks together.

“From the point of view of taking steps towards solving the problem of dealing with a new and bigger creditor base in a large set of negotiations, the Common Framework has worked,” says Bressel. “More open communication has taken place and creditors have come to the table in a more efficient manner.”

There has been a clear learning process, says Théo Maret, an associate at debt advisory firm Global Sovereign Advisory in Paris — and not just in Common Framework deals.

The Common Framework is only for nations eligible for the World Bank-IMF’s Debt Service Suspension Initiative, something Sri Lanka did not qualify for.

“There was also learning across the Common Framework and non-Common Framework restructurings,” says Maret. “It went back and forth between Zambia and Sri Lanka, for example, even if there are differences between the two cases.”

Another encouraging development from the restructurings has been the changing role of the IMF, which has always been involved, but not in the same way as now.

“The IMF and the official sector now play a big role in restructurings,” says Nazli. “They have always played a part, but at times for investors it felt like they were in the room but not physically.”

One of the changes is the IMF’s willingness to lend to a country before or during a debt restructuring, rather than waiting until after. IMF money has been a crucial factor in allowing many EM governments to avoid default since 2022, or in helping those in default muddle through while they restructure.

“IMF involvement before programmes are approved is a major improvement,” says Maret. “The IMF has lowered the bar for financing assurances before providing a programme. It’s a result of the increased trust that the IMF and the West have that China is playing ball. Things will take time and there will be hiccups, but China will not try and escape restructurings.”

The IMF’s role has caused some friction. In Zambia, for example, bondholders disagreed on the IMF’s economic assumptions for the country, which contributed to the long process.

But that is where a third success comes in — the use of variable rate instruments.

VRIs are not a new concept but including them — or not — in debt restructuring packages has been a big theme in recent talks. Zambia, Sri Lanka and Ukraine used them but Ghana did not.

VRIs, or state-contingent instruments, are bonds or loans whose terms can change, depending on triggers being hit, usually reflecting the economic condition of the borrower.

The triggers are varied. Zambia’s instruments are based on the country’s assessed debt carrying capacity and the value of its dollar exports and revenues.

In Sri Lanka, they are linked to GDP growth, and in Suriname, which restructured in 2023, they were based on oil royalties.

“The jury is out,” says Nazli. “Some are critical, believing they are too harsh on sovereigns, and there’s been criticism too that investors are leaving too much on the table.”

Another criticism from bondholders is how to price these notes, when they do not know if and when any triggers will be hit.

With Zambia there was a sense that VRIs were the only way to reach a deal. In Ghana’s case, investors wanted them but the government did not, and they did not end up in the restructuring.

“Things are getting more nuanced and more complicated in terms of pricing, but it was the only way to get these restructurings done,” says Nazli.

Maret agrees, saying there was an acceptance that VRIs were the only option when there were clear disagreements between parties, like in Zambia. “But in grey areas like Ghana and Sri Lanka, where investors argue the IMF is too pessimistic in growth or foreign exchange assumptions, it’s unclear they’re always the right solution.”

VRIs can be complex — investors have says particularly so in Sri Lanka. But for some, VRIs are helpful.

“You can question their complexity and how they are set up, but for investors like me, we now have instruments that allow you to assess risk in a much more efficient way,” says Bressel at FIM. “You have very specific risk factors you can access via these instruments, and this creation of almost a new market has partially been a function of the Common Framework.”

EM bond investors are confident there will be no sovereign defaults in 2025, barring major external shocks. The successes of 2024 leave a small group of countries in default, including Ethiopia, Lebanon and Venezuela.

Debt specialists hope that the struggles of the last few years, especially in Zambia, mean future restructurings will be a lot smoother and quicker.

But one concept is still a conundrum: comparability of treatment. The idea that no creditor should get favourable treatment is a core tenet of debt restructurings and the Common Framework.

Few argue against it as a principle. But bondholders face a problem of transparency that makes it hard for them to come up with agreements acceptable to official creditors.

“The lack of clarity on comparability is a problem,” says Maret. “Bondholders cannot do anything because they do not know whether a deal will be comparable, and this is where I am less optimistic.”

Official creditors get the first go at agreeing terms with a borrower, but they do not publish the terms of their deals. Private creditors, which includes bondholders, go next, but they do not have a clear idea of what they need to do to make their own agreement comparable to that of official creditors. They also, on top of that, have to satisfy the IMF’s debt sustainability parameters.

This problem reared its head in Zambia, when the IMF and official creditors rejected the first bondholder agreement. Fixing things with the IMF did not take long, but it took months to come up with a new deal to satisfy official creditors.

“One point markets are questioning is the one-sided nature of talks,” says Bressel. “For example, the assessment of comparability of treatment sits with official creditors, to the extent that their deal parameters are not publicised.”

Some development experts, such as Hung Tran, senior fellow at the Atlantic Council’s GeoEconomics Centre, have called for restructuring talks to include official and private creditors at the same time, or even in the same meetings.

While those involved in every debt restructuring can learn from past or concurrent processes, there are limitations.

Every country and situation has its own peculiarities. Ghana, for example, restructured its domestic debt, while Zambia did not. There was pressure in Ghana and Sri Lanka to get a deal done quickly because of elections, which would have complicated matters.

The problem of the idiosyncratic details of debt restructurings will go on, says Maret.

“For example, a Chinese policy bank may waive the event of default to provide more disbursement, and call it emergency funding, which should then not be restructured,” he says. “But the Paris Club might insist on it being included.”

Every restructuring has dozens of such “weird” technical matters, says Maret. “They can take months to be negotiated and are hard to anticipate.”