This document outlines key topics regarding debt restructuring for subnational governments, including: 1) International experience with different types of insolvency systems and challenges developing one. 2) The interaction and sequencing of fiscal rules and debt restructuring. 3) Institutions needed for borrowers regarding debt issuance and fiscal discipline, and for creditors regarding capital markets.

1. October 22, 2015
Debt Restructuring, Institutions, and Markets
Dr. Lili Liu
Global Lead, Decentralization and Intergovernmental Finance
Governance Global Practice
Equitable Growth, Finance and Institutions Vice-Presidency
The World Bank

2. Outlines
• Debt restructuring: what does international experience tell us
about types of insolvency system and challenges of
developing one?
• Fiscal rules and debt restructuring: interaction and sequencing
• Borrower: institutions for debt issuance and fiscal discipline
• Creditors: capital market – dual roles of financing and
enforcing fiscal rules
2

3. • Country-specific circumstances—history, constitution, economic structure, and entry points for
reform—influence the framework design
─ Brazil
─ Colombia
─ Hungary
─ France
─ South Africa
─ United States
• Judicial, administrative system, or hybrid
• Three essential components
─ Triggers
─ Fiscal adjustment plan
─ Debt restructuring
Subnational Insolvency System: International Experience
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4. Subnational Insolvency System: Design Challenges
• Different interest groups (think beyond creditors and debtor)
• Difference - public and private insolvency
• Strategic default
• What should be the role of government – think different levels and branches?
─ Who decides what?
• How to develop a collective framework for debt resolution
─ Motivation of US Chapter 9
─ Fresh start vs moral hazard
• Can an administrative system replicate the essentials of court-led debt
restructuring?
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5. • Insolvency system vs fiscal rules
– Insolvency system as enforcer of fiscal rules
– Debt and difficulty of adhering to rules
• Challenges in China
• Liquidity risk vs insolvency risk
• Non-discretion uniform treatment of SNGs vs addressing debt stock/profile
(non-uniformly distributed vertically and horizontally)
• Sequence of
– Debt restructuring
– Developing fiscal rules
– Adjustment path
Fiscal Rules and Debt Restructuring
Interaction and Sequence
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6. • Significant reform progress in China, for example
– National audit
– Ministry of Finance monitoring
– Reform initiatives in provinces (e.g. Hunan Debt Management Working Group, early
warning system, and three year rolling capital plan)
• Looking ahead: options
– Providing debt restructuring as incentive for reforms (medium-term budgeting, disclosure,
etc)
– DeMPA for provinces
– Developing institutions for debt management
Borrower: Institutions for Fiscal Discipline
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7. • Debt affordability criteria in Maryland:
─ Debt outstanding <=4% of State’s personal income
─ Debt service <= 8% of appropriate revenue
• Capital Debt Affordability Committee (CDAC)
─ Chaired by the Treasurer
─ Members: the Comptroller, Budget Secretary and Secretary of Transportation, and a Public
member (appointed by Governor)
─ Meets several times a year
─ Establishes debt capacity
─ Recommends annual debt authorization to Governor and Legislature
• Legislature authorizes debt in annual budget and determines particular projects to fund with debt
within the level recommended by CDAC
State of Maryland: Capital Debt Affordability Committee
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8. • CDAC annual reporting to Governor and State Assembly,
publicly available
(http://www.treasurer.state.md.us/reports/2008-CDAC-
Report.pdf)
– Tax supported debt – trends and outlooks
– Capital investment programs
– Bond rating agency reports
– Evaluation and changes to debt affordability criteria
– Debt sustainability and risk analysis
– Higher education debt
State of Maryland: CDAC
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9. • Significant progress in China
─ Emerging subnational bond market
─ Action system established
─ Capacity developing (thoughtful design by Ministry of Finance)
• Looking forward
─ Securities regulations largely similar to those for sovereign and corporate bonds
─ Market infrastructure includes regulations on credit rating agencies, broker-dealers,
underwriters, and auditors, etc
─ Addressing conflict of interests
─ Addressing competition among creditors
─ Developing effective on-lending from provinces to sub-provincial governments (project
evaluation, onlending terms reflecting risk profiles, and non-payment remedies)
─ Developing secondary market
Creditors: developing market institutions & infrastructure
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10. Yield Spread of 10-year US Municipal General Obligation Bonds
2007-2010 Q1
10
-200
-100
0
100
200
300
400
07Q1 07Q2 07Q3 07Q4 08Q1 08Q2 08Q3 08Q4 09Q1 09Q2 09Q3 09Q4 10Q1
AAA AA+
A+ BBB
Basis point
Source: Liu with Canuto “Subnational Debt Finance and Global Financial Crisis” World Bank 2010, data from Bloomberg